What if You Make a 401k Withdrawal?
Takeout is a great idea for food, but not so good for your 401k. Like IRAs, 401ks are long-term investment vehicles designed to help everyday investors prepare for retirement. Because 401ks offer tax-deferred growth and the potential for compounding interest, they can be one of the best ways to accumulate funds for retirement.
But what if you have an emergency and you need money fast? For extraordinary circumstances, there are a couple ways to take money out of your 401k — though either way will cost you one way or the other.
1. 401k hardship withdrawals
If your plan allows for it and you can prove a significant financial need, you can take a 401k hardship withdrawal. You must still be employed and be able show that you don’t have other resources to meet that need.
Employers are not required to offer either type of hardship withdrawal, so you should check with your employer to see which type, if any, is available to you. Many employers only allow hardship withdrawals for:
- Medical expenses
- Costs related to purchasing your primary residence
- Twelve months of tuition and related educational expenses for post-secondary education for you or your family
- Payments to prevent eviction or foreclosure on your primary residence
It is subject to applicable income taxes and a 10 percent early withdrawal penalty if you are younger than 59 1/2. Neither the company nor its representatives give legal or tax advice. Please consult your attorney or tax advisor for answers to specific questions.
2. 401k loans
A simpler option is to take a loan. In general, getting a 401k loan is easy. There’s little paperwork and it doesn’t require credit approval. You don’t owe taxes on what you remove — as long as it’s less than 50% of your 401k balance or $50,000 (whichever is smaller). Plus, the interest you pay on the loan goes right back into your retirement account.
Of course there are drawbacks. For one thing, you have to repay the loan
within the time specified by your plan. And you repay the loan with
after-tax dollars. If you don’t repay the loan within the time provided,
the money you borrowed is considered a taxable distribution and all tax
Keep in mind that when you pull money out of your 401k retirement account, you are reducing the amount of money that can compound. While you are slowly repaying the loan with a bit of added interest, this slow repayment plan can adversely affect the rate in which your money can grow if it remained inside your 401k as a whole amount. That's because the money wasn't working for you while it was out of the account.
The bottom line for retirement withdrawals
Avoid taking money out of your 401k if you can so you don’t have to face the tax consequences, or diminish your retirement investment.
If you must take a loan, talk with your investment professional about your options and pay close attention to the rules and regulations of your individual plan. Each plan is different and doing some homework beforehand may help you avoid painful surprises later.
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