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In 2024, a growing number of Americans are dipping into their retirement savings ahead of schedule and financial professionals are warning that it's a move that could jeopardize long-term financial security.
According to new data from Vanguard shared with Truth Sider, both hardship and nonhardship withdrawals from 401(k) accounts are rising. In 2024, 4.8% of 401(k) holders took hardship distributions, continuing a four-year upward trend. At the same time, 4.5% took nonhardship withdrawals, which are generally subject to steep penalties and tax consequences.
This behavior, experts caution, is often a last resort but one that comes with serious long-term costs.
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| Early 401(k) withdrawals are becoming more common. Vanguard |
A Costly Emergency Fund
Pulling money from a retirement account before age 59½ is typically considered a nonhardship withdrawal and incurs a 10% early withdrawal penalty, on top of standard income tax. While hardship withdrawals for expenses like medical emergencies, funeral costs, tuition, or housing needs are exempt from the penalty, they still reduce the long-term growth potential of retirement savings.
Despite this, more Americans are using their 401(k)s as an emergency fund, particularly in times of economic uncertainty or personal financial stress.
“You're often taking out money at the peak of your income,” said Chris Chen, a certified financial planner and founder of Insight Financial Strategists. “If you’re laid off in December, you’ve already earned most of your year’s income, and adding a 401(k) withdrawal just increases your tax burden.”
The timing couldn't be worse. According to Rob Arnott, founder of Research Affiliates, early withdrawals often occur during economic downturns, when individuals are unemployed and market values are down. That can compound losses dramatically.
“It’s a triple whammy,” Arnott explained. “You lose your job, your portfolio is likely down, and you’re paying taxes to access the money. It’s devastating.”
Sacrificing Future Wealth for Present Needs
Arguably the most serious consequence of early withdrawals is the opportunity cost. By withdrawing retirement funds early, investors give up years even decades of compound growth, which can significantly erode the value of their retirement portfolio over time.
“They’re essentially robbing themselves of their future,” said Bryan Kuderna, a certified financial planner and founder of Kuderna Financial Team. “You lose both the principal and all the compounded interest that money could have earned over time.”
To illustrate the impact, consider that from 1950 onward, the S&P 500 has returned an average of 11.5% annually with dividends reinvested, according to investing site DQYDJ. That kind of compound growth adds up and tapping into it early can create a hole that's difficult to recover from.
How to Avoid Early Withdrawals
So what can people do to avoid dipping into their retirement savings too soon?
One of the most effective strategies is also one of the simplest: build an emergency savings fund, even a small one. Kelly Hahn, head of retirement research at Vanguard, says having a cash buffer significantly reduces the likelihood of hardship withdrawals.
“Our research shows that having as little as $2,000 in emergency savings reduces the chance of drawing from your 401(k) when switching jobs or facing a financial emergency,” Hahn said. “It’s the single most important factor in achieving long-term financial well-being.”
Retirement Loans: A Lesser Evil
If emergency savings aren’t an option and funds are truly needed, borrowing against your retirement account may be a safer choice than a withdrawal, said Kuderna.
While not ideal since borrowers typically can’t contribute to their account while repaying the loan it avoids taxes and penalties. Plus, any interest paid goes back into your own account, rather than to a bank or lender.
Still, it’s a solution that should be used carefully and sparingly.
“It’s not perfect,” Kuderna said. “But it’s often a better choice than a withdrawal, especially since it keeps your retirement principal intact.”
When It Does Make Sense
In rare cases, early withdrawals may be the lesser of two financial evils especially when weighed against high-interest debt.
“If a client has $20,000 in credit card debt at 22% interest, then yes we bite the bullet,” Kuderna admitted. “Nothing is as financially draining as that kind of annual loss. It becomes a matter of damage control.”
Early 401(k) withdrawals may offer quick relief, but they often come at a steep long-term cost from taxes and penalties to lost compound growth and delayed retirement goals. Financial professionals agree: unless you’re facing an urgent crisis, leave your retirement savings alone.
Instead, focus on building even a modest emergency fund, explore retirement loans if necessary, and treat your 401(k) as what it is: a future lifeline, not a short-term safety net.
