Hardship withdrawals from 401(k) plans in the US hit a record high

The percentage of Americans taking so-called “hardship withdrawals” from their retirement accounts recently reached a record high, according to investment firm Vanguard.

To be sure, the percentage of workers using this strategy remains small: Only 0.5% of workers participating in a 401(k) plan took a hard withdrawal in October, but that’s the highest share since Vanguard. began tracking the number in 2004, the investment company said in a recent investor study.

Hardship withdrawals are a financial lifeline of sorts, allowing workers to tap 401(k)s for money if they have an “urgent and overwhelming financial need,” according to the IRS. The increase in hardship withdrawals comes after a challenging year for many Americans, who are facing the highest inflation in 40 years as well as a sagging stock market and slowing economy.

“It’s always a concern when you look at the participants [retirement] Dave Stinnett, head of Strategic Retirement Consulting, plans to take out the money to stave off financial hardship. “The market has been down significantly for most of the year, and there is an inflationary increase that is concerning.”

Stinnett said some IRS rule changes over the past several years have made hardship withdrawals easier for Americans. For example, a 2018 regulatory amendment Allowed workers to withdraw not only their own contributions, but also funds contributed by their employers in the company match.

“There’s less friction than before,” Stinnett said.

medical expenses, threat of eviction

Under IRS rules, hardship withdrawals can only be for the amount “necessary to satisfy that financial need.” Individuals who take money out of their 401(k) must pay taxes on the funds, but they do not have to pay taxes on the money in their account. According to the IRS, such withdrawals can be made in response to a number of financial issues, ranging from medical expenses to payments needed to avoid eviction.

There are other options for people to tap their 401(k) before retirement without necessarily invoking financial hardship. For example, people can request a loan against their retirement funds even though the money must be paid in, or they can make early withdrawals while paying a 10% penalty.

Although financial professionals generally advise against early withdrawals from retirement accounts, some workers may still need to take partial distributions if they face financial stress, Stinnett said. Also, companies that offer retirement plans to their employees may take some steps to help their employees pursue their long-term goals, such as offering financial counseling.

“Sometimes people need a coach and a reminder of the long-term benefits of keeping their money in a retirement plan,” Stinnett said. “Talking about decades of compounding, and then there’s the flip side of the coin — that’s what you lose when you take that money out.”

Millions of Americans are not financially prepared for retirement, with a recent survey from Northwestern Mutual showing the typical American now anticipates they’ll need to $1.25 million for a comfortable retirement, The average retirement account this year was $86,869.

“Participants in the plans should focus on achieving a 70% income replacement rate in retirement,” Stinnett said. “You need to save between 12% and 15% of your income each year for most people to get there”.

But, he said, it’s more difficult for people without access to company-sponsored plans such as 401(k)s. According to Stanford research, nearly half of Americans participate in a retirement account at work.

“Saving for retirement and accumulating wealth is very difficult if it is not made easy for you,” Stinnett said.

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