During the first three months of 2023, 401(k) hardship withdrawals surged 36% compared to the second quarter of 2022.1 The IRS allows hardship withdrawals to cover the cost of medical, funeral, or educational expenses. But just because these withdrawals are allowed doesn’t mean they’re a good idea. Use this guide to familiarize yourself with the consequences of 401(k) hardship withdrawals, plus alternatives if you need money fast.
The downside of early 401(k) withdrawals
- Tax penalties. Withdrawing funds from your 401(k) before the age of 59½ typically incurs a 10% early withdrawal penalty, in addition to regular income tax. This can significantly eat into the amount you withdraw and leave you with less than you anticipated. You’ll end up getting less out of your saving efforts as a result.
- Lost compounding growth. The beauty of a 401(k) lies in compound interest. The larger your balance and the longer it sits earning interest, the more you stand to make in interest alone. When you withdraw funds prematurely, you're losing out on the future growth the money could have generated.
- Retirement shortfall. Your 401(k) is designed to provide for your retirement years. Withdrawing from it early can leave you with a smaller nest egg, potentially leading to financial difficulties during your retirement.
Alternatives to secure funds
The cost of a higher education is rising about eight times faster than wages.2 This can make getting a degree extremely difficult for some individuals. Thankfully, there are options to help with the price tag that don’t involve using retirement funds. These include:
- Financial aid and scholarships. Financial aid is an umbrella term that scholarships fall under. Scholarships themselves are often merit-based. Institutions often look for strong academic performance, a history of volunteerism, or leadership skills when awarding scholarships.
- Personal loans. If you can’t afford tuition as a lump sum, a personal loan is a smart alternative to dipping into retirement savings. Select a realistic loan term to keep monthly payments manageable.
Personal loans can also help when life throws you the unexpected, such as in the event of an unexpected loss, job loss, or medical emergency. In the case of medical expenses, there are additional options. First, review your bills for potential errors or mistakes. This could be advantageous, as an estimated 80% of bills contain an error.3 If the amount you owe is correct, you can still try negotiating your bill for a lower amount. Non-profit hospitals are obligated to offer financial assistance to eligible patients.
Even if you’re not a lower-income patient, they may still be able to put you on a repayment plan. Instead of paying off the lump sum of a bill, you could make payments in installments. This may provide you with the wiggle room needed to avoid using 401(k) funds or keep your bill from landing in collections and damaging your credit.
General Electric Credit Union (GECU) is committed to Improving the Quality of Financial Lives. And that includes providing guidance to help you stay on track for the future. While it might be tempting to withdraw money from your 401(k) before retirement, the long-term consequences can far outweigh the short-term benefits. Explore alternatives, such as applying for a personal loan or building an emergency fund with an interest-earning savings account. If you're uncertain about the best course of action, consult a financial advisor for personalized guidance. GECU members can schedule a no-cost consultation with Investment Services,4 available through CUSO Financial Services, L.P. (CFS).