If you’ve been around for any length of time you’ve probably already heard that taking money out of a 401(k) early is a ‘no-no’.
There are, however, certain times that it still makes sense to raid your 401(k) and, even though there will be financial repercussions, if it’s done correctly it could be a financial lifesaver.
Below we’ll tell you how to do that with some questions that you need to answer before the deciding whether or not to take money early out of your 401(k), and how to do it. Enjoy.
First, you need to know the difference between the taxes you will get with a loan as compared with the same tax hit you will get if you withdraw from your 401(k) early. On the surface it appears to be no contest. Any money that you withdraw from your 401(k) account is going to be subject to income tax and, if you haven’t reached the age of 59 ½ yet, there will be an extra 10% tacked on as well.
Compare that to a 401(k) loan that isn’t taxable and has low interest as you might think that is a no-brainer, but loans aren’t available with every 401(k) plan. In fact, some companies only permit one loan from any particular 401(k) accounts at a time.
This has changed greatly from the days when being able to get 401(k) loans was considered one of the best ways to maximize your participation in a 401(k) plan.
If you’re still considering withdrawing money from your 401(k), there are a number of ways that you can avoid the extra 10% tax. If you’re 55 or older for example, and are no longer working for the employer that sponsored the 401(k) plan, you won’t be assessed a penalty. If you’re military reservist and get called to active duty, become disabled or are using the money to satisfy a divorce settlement under a qualified domestic relations order, the 10% penalty will in most cases be waived as well.
In order to qualify you will need to have the required documentation and know if your plan permits withdrawals or not, obviously.
Keep in mind that all withdrawals are subject to ordinary income tax and that, in some cases, the “hardship withdrawal” won’t be exempted from the 10% penalty, including foreclosure or home repairs.
One thing that you must have if you are considering taking money out of your 401(k) is job security. If, for example, you get laid off or simply go to another company, any loan balance that you might have outstanding usually needs to be paid within 60 days or else it will be treated as a distribution and the 10% extra will be assessed (if you’re younger than 59 ½ years old).
Finally there’s the chance that you have an IRA alternative. If you have an older 401(k) you might consider rolling it into an IRA because of the fact that IRAs usually have rules that are more lax for withdrawals. With an IRA you can pay for college tuition and get a penalty free withdrawal from $10,000-$20,000 (for couples) to purchase, build or rebuild your first home.
Hopefully this information has opened your eyes to the options that you have when it comes to withdrawing money from a 401(k). If you have questions or need advice, you can leave a message here or send us an email and we’ll get back to you with answers right away.