Inflation alert: Impact of withdrawing from your 401(k)

The cost of high prices

As prices rise, incomes may struggle to keep up, as evidenced by this year’s historic pace of inflation. The pressure from purchasing power has left many struggling to make ends meet. The latest evidence of this comes from the Vanguard Group (VTI), which has tracked so-called “hardship distributions” among 401(k) plan participants since 2004. In October, about 0.5% of workers took such a distribution, the highest level of any company. have ever noticed.

Most 401(k) plans allow participants to take withdrawals. According to the Plan Support Council of America, a trade group, reasons for withdrawing from retirement prematurely may include “significant financial stress,” but it mostly consists of medical bills, housing costs, and funeral expenses.

Why does this hurt savers?

Draining your retirement account early reduces your ability to take advantage of compound interest on years of saving. Also, hardship withdrawals usually carry a 10% penalty if you are under the age of 60. Plus, you lose the ability to avoid paying income tax on everything you would otherwise have saved.

Participants should note that hardship withdrawals are different from 401(k) loans, which can be repaid. If you take a hard withdrawal, you lose out on the growth and earning potential associated with your retirement account, unless you are able to secure a future investment at a higher rate of return. Furthermore, many employers prevent participants from contributing to a 401(k) plan for six months after withdrawing due to hardship.

Possible alternatives

Despite the perceived drawbacks, the persistent rise in inflation requires financial ingenuity from many families. Some immediate options for freeing up cash in the short term include canceling membership plans or selling items you don’t need anymore.

If you need a more significant cash flow, there may be other ways to handle your expenses without having to tap into your 401(k). Depending on your situation, some options could include obtaining a home equity line of credit or a short-term loan.

The decision you make depends on your individual circumstances, however, before you withdraw from your 401(k), it’s important to consider the potential long-term impact on your retirement nest egg.

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