More people are borrowing from retirement funds, with T. Rowe Price reporting that 401(k) loans were up 2 percent from 2023 to 2024, with loans rising among all demographic groups tracked in the study.
Retirement planning experts say that while it’s understandable that an emergency might trigger a 401(k) emergency withdrawal, that’s not what retirement plans were built to do.
“Recent insights from the Wall Street Journal highlight the concerning trend of early 401(k) withdrawals,” Marcel Miu, founder and lead wealth planner at Simplify Wealth Planning, told NTD by email. “A record 4.8% of workers took hardship distributions from their 401(k) plans last year, up from the pre-pandemic average of about 2%. “
Tapping into a 401(k) plan before retirement is a concerning trend and one that reflects how many households lack emergency savings. “The proper time to tap a 401(k) is when you're choosing between retirement money and true survival scenarios,” Miu said. “Someone who withdraws money for a kitchen remodel could cost themselves $100,000+ in lost growth by retirement.”
While some 401(k) plan withdrawals are understandable, especially in the case of a layoff or serious illness or injury that prevents the planholder from generating income, know that the withdrawal can significantly curb a retirement plan’s earning power and lead to extra fees and penalties.
More specifically, there are several direct outcomes, all of them adverse, that result from early 401(k) plan withdrawals.
You lose time for your money to compound.
Investing is magical when you have time for your money to grow. “Yet you lose that magic—and a ton of future purchasing power—if you pull money out early,” Michael Schramm, a chartered financial analyst and the founder of Emotional Finance, told NTD via email.
According to Schramm, a 401(k) planholder who takes out $10,000 from a 401(k) that would otherwise earn a 7 percent return is setting the stage for a substantial financial loss. “That 401(k) borrower is really losing $20,000 in 10 years, $40,000 in 20 years, and $80,000 in 30 years,” he said.
You add tax penalties by taking 401(k) cash out early.
A 401(k) plan withdrawal before age 59 triggers a 10 percent penalty as well as a tax bill, which can be as high as $37,000 of the plan proceeds. “Additionally, a $50,000 withdrawal can be punished $5,000 in plan penalties and $11,000 in tax assessment for a person with higher income earners,” Austin Rulfs, founder at Zanda Wealth, told NTD by email.
Job loss leading to accelerated loan repayment.
If a 401(k) plan borrower leaves their job, either voluntarily or via layoff, they may be required to repay the outstanding loan balance in full within 60 to 90 days of their job departure.
Better Alternatives Than Borrowing From a 401(k) Plan
To reduce the need to withdraw funds from your 401(k), aim for opening and building an emergency fund, typically in a bank savings account.
“Building a substantial traditional savings account typically minimizes the need to take out a personal loan or tack things onto a credit card,” Gina Stoddard, chief of staff at Broad Financial, told NTD by email. “Both of those choices lead to a slippery slope and can possibly leave you owing significantly more than your initial bill.”
Additionally, you can explore expanded loan provisions for Solo 401(k) account holders. “This move allows limited borrowing from the account without triggering penalties,” Stoddard said.
The views and opinions expressed are those of the interviewees. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. NTD does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. NTD holds no liability for the accuracy or timeliness of the information provided