A record number of Americans raided their 401(k)s to cover an emergency in 2023, says Vanguard — but here’s how looting your account can cost far more than you’d think

Once considered untouchable until retirement, 401(k) accounts are now doubling as emergency funds, thanks to employer auto-enrollment and policy changes that make early withdrawals easier. With medical bills growing and the cost of essentials continuing to rise, is tapping into a 401(k) a financial lifeline — or a decision that’ll cost you dearly down the road?

The hidden cost of early withdrawals

A 401(k) is meant to be a retirement savings vehicle, allowing your money to grow tax-deferred and compound over time. But life happens, and in times of financial strain, some people consider withdrawing funds early. While hardship withdrawals are allowed for medical expenses, they still come at a cost.

Take a $5,000 withdrawal, for example. If that money had stayed invested, it could have grown to approximately $5,724 over two years, assuming a modest 7% annual return. Instead, withdrawing early means losing out on that growth and getting hit with penalties. If you’re under 59½, you'll likely owe a 10% penalty ($500) plus income tax at a 22% rate ($1,100), leaving you with just $3,400 in hand.

But if you leave that initial $5,000 invested for 20 years, you’d end up with a total of $19,348 saved. And the longer you keep your money invested, the more it compounds. Even if you plan to repay the amount later, missing out on compounding returns can leave a lasting dent in your retirement savings.

Before tapping into your 401(k), it’s worth exploring other options to cover medical expenses without sacrificing your future financial security.

Explore other options

Even though withdrawing from your 401(k) can leave you with missed opportunities for financial growth, there are ways to prepare yourself in advance for emergencies, so you can have some wiggle room without needing to dip into your long-term investments.