More and more Americans are doing the unthinkable—they’re tapping into their retirement savings to pay rent and medical expenses.

According to Bank of America, the number of people who tapped into their 401(k) accounts surged 36% in the second quarter to 15,950. Their average withdrawal was $5,050.

These so-called “hardship withdrawals” have increased for much of the past year. Fidelity says the share of 401(k) participants taking early withdrawals rose to 2.4% in 2022 from 1.9% the year before.

Fund manager Vanguard says hardship withdrawals affected 2.8% of 401(k) participants in 2022 compared to 2.1% the year before.

No matter who you ask, the data is clear: Americans are struggling to make ends meet and are using their last financial lifeline to cover essential expenses.

It’s a “pretty troubling” trend, explains Matt Schulz, chief credit analyst at LendingTree. “You understand why people do that in the heat of the moment, but the opportunity costs on that are really, really high over time.”

“Opportunity cost” is one way of putting it. An early 401(k) withdrawal often replaces one financial burden with another—like kicking the can down the road.

The costs multiply

The purpose of a 401(k) account is to encourage workers to save for their retirement in a tax-advantaged way. Investments inside a 401(k) can grow and multiply without worrying about capital gains taxes and other fees—just as long as participants don’t make early withdrawals.

Raiding your 401(k) before age 59 ½ may carry a significant financial burden.

For starters, the amount of money withdrawn is counted as taxable income. It’s also subject to a 10% early withdrawal penalty. And the funds cannot be returned to the account if and when the participant’s finances improve, so they lose out on that portion’s tax-free growth potential.

In special circumstances, the IRS will waive the 10% penalty, but only if the withdrawal falls under the agency’s definition of “financial hardship.” This includes paying for certain medical expenses, funeral expenses, tuition fees, or expenses related to foreclosure and eviction.

Problem is: inflation and high interest rates— two of the leading culprits behind tighter belts—don't get a pass. So, in many cases, early withdrawals don’t meet the IRS’ limited set of conditions, and Americans are on the hook for tax penalties.

There’s some hope that President Biden’s Secure 2.0 retirement legislation will make it easier for 401(k) participants to prove they meet the hardship criteria.

Why Americans are struggling

For many Americans, their 401(k) is their only nest egg. Beyond that, there’s not much cash sitting around to help ease immediate financial burdens.

According to Zippia, a digital recruiting agency, 42% of Americans have less than $1,000 in savings. The average savings account balance is $4,500.

At the same time, household debt has ballooned by nearly $3 trillion since 2019, according to the New York Fed.

Americans owe more and have less in their bank accounts. Add a generational surge in inflation, rising rents and mortgage payments, and higher interest rates, and there’s a recipe for financial distress.

Now, experts warn of a potential rise in delinquencies as more people struggle to pay down personal loans and credit card debt.

“There’s only so much hard debt that people can handle before delinquencies really spike,” Schulz explained. “Ultimately, you just have a lot of people who are doing OK now, but it wouldn’t take a whole lot for them to find themselves in a pretty sticky situation financially, whether that is a medical emergency, job loss, or even just student loan payments restarting.”

The situation could worsen in the coming months as the federal student loan pause ends.

After being off the hook for over three years, Americans will soon have to repay their student loan balances. That alone could add $1,000 in monthly payments to an already overstretched consumer.