Withdrawing From Your 401(k): Good or Bad Idea?

29
March

Normally someone would not even think about withdrawing money from their 401(k). But, with today’s economy, money is tight. If there is an emergency situation where you need money right then, where do you turn? I’m not going to lie, accessing funds from your 401(k) for anything other than retirement is not an easy task. It’s even harder if you are still employed by the company that provides your 401(k). You still do, however, have two options. Option number one is loans.

Most every 410(k) has a loan provision. What this means is that you can borrow money from your 401(k) and pay it back to yourself without being penalized. You are, however, only allowed to borrow up to half of your balance. This amount cannot exceed $50,000. If the payment is for a house down payment, you have more time to pay the money back. But, if it is for anything else, you have up to five years to pay it back at competitive interest rates. If you do decide to withdraw, there will not be a credit check and most companies will not care how you are using the money. All it takes is calling in your request and you will receive a check in the mail within a few days. Sounds really simple right? Just don’t forget, when you pay it back, not only are you paying back what you borrowed. You are paying back what you borrowed plus interest.

Although, it all sounds great, it is not recommended that you withdraw anything at all unless it is absolutely necessary. The whole point in having a 401(k) is to have a tax free investment that will grow over the years so you can have money to live on after retirement. Of course, it is like borrowing money from yourself so the question is, why is it bad to withdraw if the money is going right back to me? Well, yes, you are paying back the money with interest to yourself, but if you were to leave your investment alone, you will make better returns and your income would be tax free. Also, you are putting your retirement at risk. If you were to lose your job or you were to leave your job for a better opportunity, the loan would be due in full at that moment. If you are unable to pay it back, it is treated as an early withdrawal and penalties will apply. So, if you want to take out a loan, make absolute certain that you are secure in your job.

When does taking out a loan make the most sense? If you are in desperate need for money and you don’t have any other sources, it makes sense to withdraw. Unfortunately, many 401(k) loans are used for things like vacations. If you are secure in your job and disciplined enough to pay the loan back in five years, your investment won’t be damaged that much. But, you will lose five years of compounding. It is always best to only borrow from your 401(k) if you are in a bind. Some examples would be if you are in need of a down payment for a home or if your kid’s school tuition is due. Even under these circumstances, it is always best to compare all available options before making your decision.

Another option for withdrawing from your 401(k) is a hardship withdrawal. Only consider this if you are willing to do serious damage to your retirement goals. If you go this route, you will have to pay income taxes along with a 10% federal penalty. On top of these penalties, you are also not allowed to contribute to your account for six months after making the hardship withdrawal.

Fortunately, it is difficult to withdraw the funds in this manner if you still work for the company. The only real way to access the funds is if you need to pay medical expenses, cover the down payment or keep from having to foreclose on your home, pay college tuition or cover funeral expenses for a family member. Some other plans may take other situations into consideration but all will request documentation stating that you have no other assets before you are allowed to withdraw.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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