At some point, you might have more money in your 401(k) than any other investment. Even though it’s intended for retirement, you might think you have to tap into your account early.
However, if it’s possible to avoid taking money from your 401(k) before retirement, you should do so. You could spend many years in retirement and will need to pay for those years. Look for alternatives — an emergency fund, health savings account or selling taxable investments.
Some plans allow loans. Employees generally can borrow up to 50% of the vested amount of their 401(k)s, up to $50,000 within a 12-month period. Administrative fees might apply, and interest will be charged, but it will be added back to the 401(k) account as part of the loan repayments. Except when used for a home purchase, loans must be repaid within five years typically, with equal payments made at least quarterly. If you leave the company or don’t repay the loan according to the agreement, the loan balance likely will be treated as a taxable distribution.
Some 401(k) plans allow current employees to make withdrawals. Requests usually are categorized as hardship or nonhardship. To qualify for a hardship withdrawal, you must demonstrate an immediate and heavy financial need, and your withdrawal is limited to the amount necessary to meet the need. Nonhardship withdrawals typically can be made for any purpose but usually are not granted until you’re 59½ or older.
Unlike a loan, a hardship withdrawal can’t be repaid, while a nonhardship withdrawal usually can be repaid, but only by rolling over the amount to an individual retirement account within 60 days. The bigger issue might be taxes. If you withdraw funds from your 401(k), any previously untaxed money generally is taxed as ordinary income, and a 10% penalty will apply if you’re younger than 59½ (unless you qualify for an exception). Plus, your 401(k) plan typically must withhold 20% of the withdrawal for taxes, so you’d have to take an even larger withdrawal to meet your needs.
Before considering a 401(k) loan or withdrawal, consult with a financial professional and your tax advisor. Taking money from your 401(k) is a big move, so make sure you know everything that’s involved.
This article was written by Edward Jones for use by your local Edward Jones financial advisor. Edward Jones, member SIPC
– Roberto De Jesus is a financial advisor for the Edward Jones branch on Cedarcrest Road in Acworth.