Why does life derail you when you can least afford it? Job layoffs, medical expenses, unexpected home repairs, tuition or a combination of needs can squeeze the life out of your cash availability. So you weigh your options. Are there assets you can draw on? If not, what about your 401k?
Traditionally, withdrawing or borrowing from a 401k has been frowned upon. Despite the fact that you’re borrowing from yourself, interest, penalty, and lost opportunity costs might make it a very expensive choice.
However, with the help of your CPA and a solid understanding of your 401k, you can minimize losses should you need to dip into it.
What does your plan say?
Rules vary between 401k plans. Some allow loans. Some don’t. Some allow multiple loans. Others allow only one. Most limit what you can borrow to fifty percent of the plan’s value, up to $50,000. And certain plans require a loan before you can take a hardship withdrawal.
If you’re younger than 591/2, there is generally a 10% tax penalty. But other factors come into play too. Your military reserve status, disability, a divorce settlement or unreimbursed medical expenses can help mitigate penalties.
Where is your plan?
Are you still working for the company that holds your 401k? If so, do you plan to be there for a while? Why? Because if you leave the company, loans from your 401k must usually be paid back within sixty days or you will be taxed on the money you borrowed. If your future there is uncertain, this could be risky.
If you’ve moved on, but your 401k hasn’t, you may be able to lessen penalties by taking periodic payments vs. a lump sum.
How will a withdrawal affect future earnings?
Money removed cannot earn dividends. So it’s good to consider the hit to your earnings when you interrupt their growth. Also, check any restrictions on making contributions to your 401k after taking a hardship withdrawal. Some plans will make you wait six months.
The point is, when “stealing” from your 401k is your only option, run the numbers with your financial advisor and your CPA. Then proceed knowing you’ve done your homework.