More People Are Tapping Into Their 401(k)s During Hardship. Here's Why
KEY POINTS
- Nearly 3% of 401(k) participants took a hardship withdrawal in 2022, primarily to cover housing expenses.
- Many Americans are pessimistic about their financial situation right now.
- Consider an alternative like borrowing money from friends or family or using a 0% credit card offer rather than taking a hardship loan from your retirement savings.
Covering a significant, unexpected expense can wreak havoc on your finances, and when difficult times happen, some people turn to their 401(k)s for help. And unfortunately, a larger percentage of 401(k) participants are tapping into their retirement savings than ever because of hardships.
According to the latest data from investment broker Vanguard, a record 2.8% of people with a 401(k) accessed their retirement savings because of hardship last year, an increase of about 65% from 2020.
Here's why Americans are reaching for their 401(k)s for financial help.
Why people are tapping their 401(k)s right now
In its report on America's savings habits, Vanguard said that more people may be tapping into their 401(k) brokerage accounts because of financial stress. The top reason why people needed extra financial help last year was to avoid a home foreclosure or eviction.
The data shows that 36% of 401(k) participants who tapped their retirement savings did so to help them with their housing costs. The second biggest reason -- 32% of those who took hardship withdrawals -- was to cover medical expenses.
The cost of housing has skyrocketed over the past few years, which may lead to the threat of foreclosure and evictions for some Americans.
Federal Reserve data shows that the median price of a home is now 29% higher than it was just three years ago, reaching $416,000 in the second quarter of this year. And Rent.com data shows that the median rent prices have increased 17% over the past three years.
Americans aren't optimistic about their finances
The rapid rise in housing costs and a historic increase in inflation will likely contribute to financial pressure for some people. Americans have $5.5 trillion less in their savings accounts than they did in mid-2020, according to recent Barchart data, and have less money saved up than before the pandemic.
And Americans don't appear optimistic that things will turn around for them any time soon. A Gallup poll released in May showed that 55% of Americans rate their financial situation as "only fair" or "poor" and half of all of the respondents said that their financial situation is worsening. In contrast, just 37% said that their financial situation was getting better.
The poll also showed middle-income Americans appear the most pessimistic about their finances. Gallup said that over the past year the financial confidence of Americans earning between $40,000 to $99,999 annually had fallen to its lowest level in 20 years.
Why you should avoid a hardship withdrawal if possible
If you can avoid it, it's best not to tap your 401(k), even during a hardship. When you do, you have to pay taxes on your withdrawal.
For example, if you have a traditional IRA, your money is invested with pre-tax dollars. That means when you take your distributions in retirement -- or take an early withdrawal because of a financial hardship -- you'll need to pay taxes on it.
Additionally, while you don't have to pay an early withdrawal penalty for hardship withdrawals, you will lose out on future gains you could have made. The more money you have in your investment accounts and the longer you keep it there, the more it grows. Thus, taking some of it out of your account will reduce your potential gains.
Tapping into your 401(k) to cover housing or medical costs may be necessary for some people, but just make sure you know the drawbacks to doing so before you decide.
Alternatives to a 401(k) loan
While it can be tempting to borrow money from your 401(k), it may be worth considering some other options before you do.
For example, many people borrow money from friends and family to help them through financial difficulties. The Consumer Financial Protection Bureau says that 1 in 5 Americans have borrowed money from friends and family, and about 33% of U.S. adults have provided financial support to others.
While it can be awkward to go this route, it may be preferable to do so rather than taking money away from your retirement savings. To make borrowing from friends and family easier, the Pigeon app can help you set loan terms and track payments.
If you want to avoid borrowing from friends and family altogether, then it may be worth considering a 0% credit card offer. While you should be careful when using credit cards for expenses, some cards offer 0% interest for up to 21 months on purchases and balance transfers, making them an inexpensive option for short periods.
Just make sure you pay your credit card balance every month to avoid racking up credit card debt, and keep track of your expenses to ensure that you're staying within your budget.
Borrowing money from your 401(k) may seem like the easy route, but make sure you consider all of your options before doing so to ensure you're making the best financial decision.
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