Hardship withdrawals should be a “last resort,” said Joni Alt, a senior wealth adviser at Evermay Wealth Management in Arlington, Va. She suggested exploring other alternatives first, like a home equity line of credit.
Jeanne Sutton, a certified financial planner with Strategic Retirement Partners in Nashville, said that in her experience, the top reasons for hardship withdrawals are medical debt and the purchase of a new home. “Most of the time, they don’t have options that are better,” Ms. Sutton said. People with large medical bills should try to negotiate a payment plan before tapping retirement funds, she said.
Absent other options, a loan from a 401(k) may be better than a withdrawal, Ms. Sutton said, as long as you pay it back on time — and don’t make it a habit. You won’t owe taxes and penalties with a loan. You’ll pay interest — but you’ll be paying yourself, because it will go back into your retirement account.
The downside is that you will lose out on potential long-term market gains on the funds you borrowed. “You lose the greater value, which is the value of compounding,” said Jeff Cimini, the senior vice president of retirement product management at Voya Financial.
And taking out a 401(k) loan may be particularly risky if you’re worried about job security, because some employers may require you to repay it quickly if you leave your job or are terminated.
Loans from 401(k) accounts have become less popular since the 2008 financial crisis, as rules for hardship withdrawals have become more flexible, according to Vanguard. Federal legislation in 2018, for instance, eliminated the requirement that workers must take out a loan before taking a hardship withdrawal.
Still, some data shows that loans from 401(k)s have also ticked up recently. Empower said loans increased by 13 percent between September of this year and last. Vanguard said 0.9 percent of its plan participants borrowed from their retirement accounts in October, up from 0.8 percent at the beginning of the year. Fidelity, however, said the proportion of 401(k) savers taking out a new loan remained “low,” with 2.4 percent of plan participants doing so in the third quarter of this year.