Amid stubbornly high inflation and sagging savings rates, more Americans are tapping their 401 k accounts for financial emergencies. A record 2.8% of the five million people in 401 k plans run by Vanguard Group took hardship withdrawals in 2022, the company said, up from 2.1% in 2021 and a pre-pandemic average of about 2%.
Hardship withdrawals allow workers to take money out of their 401(k) plans when facing an "immediate and heavy financial need." These can be used for medical bills, first-time home purchases, college tuition, rent or mortgage to avoid foreclosure or evictions, funeral expenses, and home repairs. However, they can come with a host of penalties. That's why you should be sure to understand your plan's details before withdrawing funds. According to data from Vanguard Group, nearly 0.5% of savers took a hardship distribution in October; the highest share since the company started tracking it in 2004. That dynamic -- along with fast-rising credit card balances and a declining personal savings rate -- suggests that households are facing a deterioration in their finances. If you're 50 years or older, you can contribute up to $7,500 per year (up from $6,500) into your 401(k) plan through 2023. In 2025, the limit will increase to $10,500. Catch-up contributions can help you bolster your savings early in your career and boost your nest egg before retirement. But be sure to understand how these contributions work so you don't accidentally over-contribute and trigger tax problems later. Hardship withdrawals from a 401(k) are another common way to access funds in retirement. But they come with significant drawbacks. Unlike IRA hardship withdrawals, which are generally not subject to the 10 percent penalty, 401(k) withdrawals are generally taxable. Amid record growth in the stock market and a booming economy, 401 k hardship withdrawals have become more common. However, many people need to understand how a hardship distribution from their 401 k works or how they affect their tax liability. The Secure 2.0 Act, which became law at the end of 2022, makes 401 k hardship withdrawals easier by removing some rules around them. The new regulations aim to allow more individuals to access their retirement savings without fear of penalties and taxes. 401k hardship distributions are generally not subject to the 10% early withdrawal penalty. Still, they require an employee to provide written certification that they have no other means of paying for the hardship. The new rule allows plan administrators to rely on this certification rather than seeking more information. This could save plan administrators time and money, especially during high-cost medical emergencies. The new retirement rules make accessing money in a 401 k plan easier if you face an "immediate and heavy financial need," such as medical expenses or tuition and education. However, it's important to note that a hardship withdrawal can negatively impact your future retirement. If you're concerned about a participant using their retirement account to meet a financial need, a good first step is to request that they provide a statement of why they are taking the distribution. This is called self-certification, and it's not required, but it can help you identify if your participant has a valid reason for the withdrawal. As a result of the changes made by President Trump and Congress, 401 k hardship distributions have skyrocketed. According to Vanguard research, 2.8% of employees in its five million-member plans tapped into their retirement accounts for hardship in 2022 -- the highest level ever recorded. But even though this is a positive sign for the economy, financial advisors warn that it can also mean Americans lose out on future investment gains.
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