Although it is possible to withdraw money from your 401(k) plan before you retire, it is almost always a bad idea.
Designed to give individuals control over their retirement savings, 401(k)s enable employees to set aside pre-tax earnings into personal accounts. However, strict requirements and penalties apply to early withdraws from these accounts.
If you do withdraw money, you will have to include the funds you receive as income when you file taxes, and the withdrawal may be subject to an additional 10% tax penalty (unless you are 59 1/2 years old). This penalty is added on to your tax bill after you calculate deductions, so it has a dollar-for-dollar impact.
Your employer can provide you with the details regarding your specific plan and the withdrawal options. These options allow for withdrawals in the case of certain “hardships” defined by the IRS and listed below.
“Hardship” Withdrawals
The IRS defines various hardships for which your employer may allow you to withdraw 401(k) funds prior to retiring. These may include education or medical expenses for a family member; funds to purchase, repair, or prevent foreclosure on your home; funeral costs; and certain other expenses.
Certain hardships even waive the 10% penalty tax. For instance, if you need to redeem your 401(k) due to “total and permanent “disability there is no penalty, but you must still pay taxes on the funds.
Consider Other Options
As tempting as it may be, be sure to look to all available alternatives before you rob your retirement nest!
Some plans have loan provisions. Your 401(k) may allow you to borrow as much as half of your current balance. The interest you pay on this loan goes back into your own account! A home equity loan may be a better option (although “home equity” isn’t the source of funds it once was).
If other savings or loan sources are available, consider using them before you accept the tax penalties that accompany a 401(k) withdrawal. Early withdrawals from a 401(k) should be considered as a last resort, used only when other funding sources have been exhausted.
In addition to the penalties, you’ll forfeit the benefit of potential tax-deferred growth of your retirement funds.
In many cases, you have better options.
*This article is intended for informational purposes only and should not be construed at investment advice. Please consult an accountant or other licensed financial professional before making any financial or investment decisions.
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