3 Emergency Expenses That Push People To Raid Their 401(k) — and Money Moves To Avoid It
Just as you feel confident about your retirement savings, you’re hit with a massive medical bill, major damage to your house or unexpected taxes. If you’re one of the millions of Americans without a robust emergency fund, taking a hardship withdrawal from your 401(k) may seem like your best option.
Unfortunately, what feels like a lifeline in a difficult moment can end up costing you significantly in retirement. MoneyLion wanted to know what’s driving people to raid their 401(k) accounts — and which money moves they should consider before doing something drastic.
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Leading Reasons People Make Hardship Withdrawals
To understand the leading causes of hardship withdrawals, MoneyLion spoke with AJ Osborne, CEO of Cedar Creek Capital, and Chris Heerlein, CEO of REAP Financial. Here’s what they said.
Medical Bills
Medical bills are “the biggest factor that catches people off guard, hands down,” Osborne said, referring to emergency expenses that can lead to hardship withdrawals from a 401(k).
These costs are especially difficult because they’re often unexpected. After all, who plans on getting sick or having an accident?
“It’s an emergency situation,” Osborne said. “It’s usually really bad because it racks up lots of money.”
Housing Issues
Housing-related problems have also compelled people to make hardship withdrawals. According to Osborne, these issues often take the form of significant repairs or sudden increases in taxes or insurance — problems that can have severe consequences when compounded.
“We see things like roof repairs that cost $30,000, or it’ll be property tax reassessments or insurance hikes,” Osborne said. “Or those two things combined can lead them into foreclosure.”
Aging Parents
Heerlein described caring for aging parents as one of the least-discussed financial emergencies. While many people expect they may need to help their children financially at some point, they may not anticipate the cost of supporting a parent who suddenly can’t drive or needs help paying rent. That doesn’t even include the expense of in-home care.
“It’s surprising to realize that an extra $1,000 to $3,000 per month has stealthily crept into the monthly budget with no end date in sight,” Heerlein said. “That recurring expense drives many people to raid retirement savings accounts because it seems ongoing rather than temporary.”
Why Hardship Withdrawals Aren’t the Wisest Move
Given how significant these emergencies can be, you might wonder why experts generally advise against making a hardship withdrawal from your 401(k). Their concern centers on the long-term consequences for retirement savings.
“Once you pull that money out, you lose all the potential growth it could have had over the years,” Heerlein said. “Having more options is often better than taking the easiest or cheapest path in the short term.”
Osborne explained why the math often doesn’t work in your favor:
“A 35-year-old who pulls out $20,000 doesn’t just lose $20,000,” Osborne said. “They could lose roughly $200,000 in compounded retirement value. Plus, they pay income taxes and a 10% penalty on the way out the door. You’re solving a $20,000 problem that can have a $250,000 impact.”
So, what can you do instead of making a hardship withdrawal from your 401(k)?
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Smart Money Moves To Avoid Hardship Withdrawals
Osborne and Heerlein suggest several alternatives to tapping your retirement savings.
Negotiate Payment Plans
Hospitals, contractors and even the IRS may be more willing to work with you than you think, Osborne said.
“Hospitals, contractors and the IRS will almost always set up payment plans, often interest-free, but people are really afraid to ask,” Osborne said.
Tap Roth IRA Contributions
Osborne also suggested tapping Roth IRA contributions before making a hardship withdrawal. Many people don’t realize that Roth IRA contributions can be withdrawn tax- and penalty-free at any age.
That said, while contributions can typically be accessed freely, withdrawing investment earnings from a Roth IRA before age 59½ and before the account has been open for at least five years may trigger taxes and penalties. It would be wise to consult a tax professional before you make this move.
Use a 0% Intro APR Credit Card
According to Osborne, a 0% introductory APR credit card can serve as a short-term bridge to cover an emergency until you’re able to pay it back.
“So instead of withdrawing, utilize a financing option that accrues no interest to bridge the gap until you can accumulate that amount,” Osborne said.
The key here is to repay the balance before the promotional period ends so you don't accrue interest charges.
Open a HELOC if You Have Home Equity
Finally, Osborne recommended considering a home equity line of credit, or HELOC, before making a hardship withdrawal if you qualify.
“Instead of just taking it out, get a HELOC on a home if it has equity,” Osborne said. “Rates may be higher than they were three years ago, but you can keep your retirement savings compounding in the market and lock in that rate.”
The Bottom Line
Making a hardship withdrawal from your 401(k) is not a casual decision. Fortunately, there are several potentially less damaging alternatives worth considering first.
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This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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