How Early 401(k) Withdrawals Widen the Racial Retirement Gap

Black and Hispanic savers are more likely to take money out before they retire, and the costs can be high

Tamara E. Holmes,

AARP

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En español

Published September 05, 2024

two groups going up diverging arrows superimposed over nest eggs

Rose Wong

A growing number of American workers are turning to their 401(k) plans to cover unanticipated financial disruptions, like a medical emergency or unexpected layoff. In a June report, financial services company Vanguard found that the number of people enrolled in its 401(k) plans who are making withdrawals from their accounts has been steadily increasing since 2020.

For workers under age 59½, that usually comes with an immediate price: early withdrawal fees amounting to 10 percent of the amount taken out. But the financial consequences can linger for years. Each withdrawal from a retirement plan means less money in the account earning compounding returns and, over time, a significantly diminished nest egg.

Perhaps more alarming, early withdrawals don't affect all communities equally. Black and Hispanic workers “are taking out money more frequently from their retirement savings than others,” says Kara Woolley, senior program manager for the Inclusive Saving and Investing Initiative at the Aspen Institute Financial Security Program.

Major purchases, emergencies drive withdrawals

Taha Choukhmane and Lawrence Schmidt, assistant professors of finance at the MIT Sloan School of Management, published a working paper in August on racial gaps in retirement savings. They found that among workers who made at least $1,000 in recent contributions to a retirement plan, 12 percent of white savers were likely to make an early withdrawal in a given year, compared to 15 percent of Hispanic savers and 23 percent of Black savers.

“The rate of early withdrawals among Black Americans is almost twice as high as among white workers,” Choukhmane says. “These gaps remain really large even when we compare workers who work at the same firm, make the same amount of earnings and have the same level of education.”

A March 2024 report from the Collaborative for Equitable Retirement Savings, a joint initiative of the Defined Contribution Institutional Investment Association, the Aspen Institute Financial Security Program and Morningstar Retirement, echoes those findings.

Not only are Black and Hispanic workers more likely than white peers to make early withdrawals, but Black workers tend to withdraw larger percentages of their retirement savings than other groups, and Black and Hispanic workers are more likely to have outstanding loans from their 401(k) accounts, the study found.

What are these workers using the money for? Oscar Moreno, a Denver-based financial adviser at financial services company Thrivent, says three of the most common reasons he sees Black and Hispanic clients withdrawing money from their 401(k) plans are to cover medical expenses, start a business or make a down payment on a home.

Workers who experienced a recent job loss are also more likely to make an early withdrawal, according to Schmidt and Choukhmane’s research. “People are not taking [the money] to blow it on fancy vacations,” Choukhmane says.

Not just about income

It’s no secret that Black and Hispanic workers earn less than their white counterparts, but the disparity in early withdrawals persists even when income gaps are absent, Woolley says. “Our findings are showing that people with the same retirement savings plan and making the same amount will end up with vastly different balances in their accounts,” she says.

That means other factors make it more likely for workers of color to take early withdrawals from their retirement accounts. Among them:

They often have less wealthy parents. Older white adults tend to have more wealth than older people of color, Federal Reserve data shows, meaning Black and Hispanic workers are less likely to have parents they can fall back on for financial assistance in times of need. According to Choukhmane and Schmidt’s research, workers whose parents were high earners were less likely to make early withdrawals than those whose parents were not wealthy.

They frequently have conflicting financial goals. A 2022 T. Rowe Price study found that Black 401(k) contributors were more likely to prioritize other savings goals, such as socking money away for a down payment on a house, over saving for retirement. Black plan participants were also more likely to have student loan debt, putting an extra strain on their finances.

“You have just a limited amount of money that you can save, and there are all these different priorities,” says Sudipto Banerjee, director of retirement thought leadership at T. Rowe Price. “People are probably tapping into their retirement savings for some of these purposes.”

They are more likely to give to friends and family. According to research by the University of Massachusetts Boston, lending money to relatives and friends is more prevalent among people of color. That generosity often comes at a cost, as households that provide financial support to loved ones are more likely to take out 401(k) loans and have larger loan balances.

They may be less likely to qualify for a business loan. White entrepreneurs are twice as likely to get approved for small-business loans as Black and Latino entrepreneurs even when all present a low credit risk, according to research by the New York Fed. “Many individuals use 401(k) savings to start or expand businesses due to limited access to traditional financing options,” Moreno says.

4 things to do before making an early withdrawal

Remember that every dollar you keep in your 401(k) plan is a dollar invested in your future. That’s no small thing, especially if you’re nearing retirement. “You don’t want to raid your retirement to finance your everyday problems,” says Mark Charnet, founder and CEO of American Prosperity Group in Sparta, New Jersey. These four considerations can help you avoid that.

Make sure it’s a true emergency. Taking money from your retirement account should be an option of last resort. It’s one thing if you’re out of work and need money to put food on the table, but using retirement funds to pay for a vacation or home improvement project might have the effect of sacrificing future retirement security for fleeting pleasure today.

Look into other options. Before reaching into your 401(k), see if there are other solutions, such as tapping the cash value of a permanent life insurance policy, Charnet suggests. You could also consider taking out a home equity line of credit or getting a part-time job temporarily.

Bulk up your emergency fund. Sure, you want to maximize 401(k) contributions, but it might be wise to save a little less for retirement so you can set aside something for emergencies, Banerjee says. Even if you can only afford to save a little at time, allocate a portion of your paycheck to each goal and build up a solid rainy-day fund — three to six months’ worth of living expenses — that you can turn to if needed.

Consider economic assistance programs. “There are community assistance programs people can leverage in lieu of pulling from their hard-earned retirement accounts,” Moreno says. Check into what’s available from your state and local government, and from charities and community organizations in your area.

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Tamara E. Holmes is a Washington-based writer and editor. She has written extensively about money, entrepreneurship and careers for more than two decades. Her work has appeared in such publications as USA Today, Working Mother and Essence.

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