Do this instead of an early 401(k) withdrawal

A new report shows more Americans are making hardship withdrawals, costing them money in the long run. “If you took $10,000 out of your 401(k) at age 30, at full retirement age, that’s $64,000 that you’ve missed out on if you have typical market growth,” said Jessica Roy, a personal finance columnist for The San Francisco Chronicle.

Driven by inflation, higher borrowing costs, and easier access to one’s retirement funds, hardship withdrawals have more than doubled since 2018. According to a new Vanguard report, the percentage of participants taking hardship withdrawals last year reached 6% – a record high.

This increase in withdrawals is partly due to the Secure 2.0 Act, which, enacted under President Biden, allows people to withdraw up to $1,000 penalty-free, with certain rules attached. “The typical amount taken was only $1,900, which points to…kind of a financial emergency,” said Roy.

Hardship withdrawal vs. early withdrawal

An early withdrawal is one made before the age of 59 ½ and is typically subject to federal income tax and an additional 10% tax.

That means if you choose to make an early withdrawal of $10,000 and are taxed 30%, the additional 10% penalty tax on early withdrawals would leave you with just $6,000.

A hardship withdrawal is a type of early withdrawal that allows you to access retirement money for certain IRS-approved emergencies. Although both types of withdrawals will incur a federal tax, a hardship withdrawal that meets the criteria for a separate IRS exception will avoid the additional 10% tax.

When does it make sense to make an early 401(k) withdrawal?

Financial experts say an early 401(k) withdrawal should generally be a last resort because you’re giving up years of potential investment growth.

That said, if you’re facing a true financial emergency—such as foreclosure or a major medical bill—and qualify for a hardship withdrawal, tapping your retirement savings may be the best option.

But if you’re considering an early withdrawal to pay off credit card debt, Roy says to think twice. A hardship withdrawal is meant for specific emergencies, and using retirement savings to erase debt doesn’t address the underlying financial issues that may have caused it.

What are some alternatives to accessing a 401(k) early?

If you’re in a financial bind, there are alternatives to accessing your 401(k) – especially if you have credit card debt.

“Almost every single credit card company and utility company has what’s called a hardship program,” said Roy.

A hardship program is a temporary arrangement with a credit card company that can lower your interest rate, reduce your monthly payment or waive fees. However, it may not always be advertised.

“It’s really something you have to pick up the phone and call,” she said.

Another option is to contact a nonprofit credit counseling organization to help evaluate your options. You can also look into getting a 401(k) loan. With a loan, you essentially borrow money from yourself and pay back the interest over time. The interest payments and principal go directly into your 401(k) account.

If you’re struggling financially but still want to contribute to your 401(k), an additional option is to reduce your contributions.

“Dropping it back down to that employer match level means you’re still getting your full work benefit,” said Roy.

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