Understanding your 401(k): How it works and why it matters.
What is a 401(k) plan? Key benefits and how to maximize your savings.
More Americans are using their 401(k) retirement accounts as personal ATMs.
Last year, 6% of Vanguard retirement savers made difficult withdrawals from their 401(k) accounts, the highest amount ever. The needy share has increased dramatically in recent years, up from 1.7% in 2020.
Even among Fidelity’s retirement savers, withdrawals from those in need have increased rapidly.
Overall, American companies and their employees are doing a better job of saving for retirement. For example, 61% of Vanguard retirement plans now automatically enroll new employees in a 401(k), up from 54% in 2020. Automatic enrollment tends to increase your savings rate.
But the rise in withdrawals by those in need suggests that some retirement savers are financially vulnerable. That means living paycheck to paycheck and not having enough savings outside of retirement accounts for emergencies.
“It’s still a small number at 6%, but it’s worth noting,” said David Stinnett, director of strategic retirement consulting at Vanguard. He said the median hardship withdrawal in 2025 will total $1,900. The most common reason for withdrawal was to prevent foreclosure or eviction.
Tapping your 401(k) is now easier than ever
Federal law is increasingly allowing raids on Americans’ retirement accounts, which may be one reason for the rise in withdrawals among people living in poverty.
For example, starting in 2024, many retirement savers will be allowed to withdraw up to $1,000 a year for emergency expenses, allowing savers to define what counts as an emergency.
But these transactions come with costs, and financial experts say retirement savers should usually use the funds only as a last resort.
“When you raid your 401(k) for a quick cash grab, you’re essentially robbing your future self of benefits,” says Caleb Silver, editor-in-chief of Investopedia.
The point of a retirement account is to build up savings to get you through the years when you’re not working. The design of a 401(k) relies on compound interest. If you start saving young and invest in stocks and bonds, your savings can grow exponentially as your investments grow in value over time.
If you raid your retirement accounts too much, you could lose not only the money you withdraw, but also any potential future investment returns.
“Withdrawals early can prevent the long-term growth and compounding of your retirement savings, which you will need in the future in retirement,” said Katherine Collinson, CEO of the nonprofit Transamerica Retirement Research Center.
This is perhaps the biggest drawback of raiding retirement accounts. If you withdraw money before age 59 1/2, you generally have to pay a 10% IRS penalty on the amount, which is also taxed as income.
However, there are many exceptions to that rule. For example, hardship withdrawals won’t incur the 10% tax penalty if done properly. Many other life events and emergencies qualify you for early withdrawal from your 401(k) or IRA plan without penalty.
Here’s an overview:
401(k) Hardship Withdrawal
Some, but not all, 401(k) plans allow retirement savers to make difficult withdrawals without incurring tax penalties.
In recent years, rules regarding withdrawals for needy people have been relaxed. Starting in 2024, you’ll be able to cash out up to $1,000 for emergency needs.
Under the new rules, hardship withdrawals can only be made once a year. You won’t be able to earn any new money for three years unless you pay it back or make new contributions to cover the balance.
Older IRS rules allow hardship withdrawals of more than $1,000 for 401(k)s, but the rules are stricter.
Greater hardship distributions must meet “immediate and severe economic need” and must be limited to the amount “necessary” to meet that need.
Your employer will decide whether your needs are “urgent and serious.” Again, the IRS offers some guidance. Consumer purchases such as televisions and RVs generally do not qualify.
The IRS lists several scenarios that “automatically” qualify you for a hardship withdrawal.
- Medical expenses for you, your spouse, or dependents
- Costs associated with purchasing a home (excluding mortgage payments)
- Secondary education costs for you, your spouse, or dependents for the following year
- Payments to prevent eviction or foreclosure
- Funeral expenses for you, your spouse, children, and dependents
- Some costs to repair damage to your home
Eligible early withdrawal
Retirement savers are typically allowed to make early withdrawals from 401(k) accounts and IRAs without tax penalties in some scenarios that involve a mix of financial emergencies and life events.
The rules and limits for qualified early withdrawals are set by the IRS, not you or your employer. Here are some examples:
- Birth or adoption expenses, $5,000 per child limit
- Death or “total and permanent disability.” There are no restrictions.
- Disaster Recovery, up to $22,000 for federally declared disasters.
- education. Only IRA savers can withdraw funds to cover qualified higher education expenses
- Medical expenses. Retirement savers can withdraw funds to cover unpaid expenses that exceed 7.5% of their adjusted gross income.
- Purchase a house. IRA savers (only) can withdraw up to $10,000 to purchase their first home.
401(k) loan
With a 401(k) loan, you borrow money from your account and pay it back over time, with payments and interest credited directly to your account.
Depending on your plan’s rules, you may be allowed to borrow up to half of your account’s committed balance, up to a maximum of $50,000. If your confirmed balance is less than $10,000, you may be able to borrow up to $10,000.
Loans are typically repaid within five years and must be paid at least quarterly. If the loan is for a home, it may be for more than five years.
Fidelity reports that one of the benefits of a 401(k) loan is that you don’t pay taxes or penalties on the funds. Interest will be charged, but you will pay it yourself.
One downside is that if you quit your job, you may have to repay the loan quickly.
