If you have a 401(k) plan at work and need some cash, you
might be tempted to borrow or withdraw money from it. But keep in mind that the
purpose of a 401(k) is to save for retirement. Take money out of it now, and
you'll risk running out of money during retirement. You may also face stiff tax
consequences and penalties for withdrawing money before age 59½. Still, if
you're facing a financial emergency--for instance, your child's college tuition
is almost due and your 401(k) is your only source of available funds--borrowing
or withdrawing money from your 401(k) may be your only option.
Plan loans
To find out if you're allowed to borrow from your 401(k)
plan and under what circumstances, check with your plan's administrator or read
your summary plan description. Some employers allow 401(k) loans only in cases
of financial hardship, but you may be able to borrow money to buy a car, to
improve your home, or to use for other purposes.
Generally, obtaining a 401(k) loan is easy--there's little
paperwork, and there's no credit check. The fees are limited too--you may be
charged a small processing fee, but that's generally it.
How much can you borrow?
No matter how much you have in your 401(k) plan, you
probably won't be able to borrow the entire sum. Generally, you can't borrow
more than $50,000 or one-half of your vested plan benefits, whichever is less.
(An exception applies if your account value is less than $20,000; in this case,
you may be able to borrow up to $10,000, even if this is your entire balance.)
What are the requirements for repaying the loan?
Typically, you have to repay money you've borrowed from your
401(k) within five years by making regular payments of principal and interest
at least quarterly, often through payroll deduction. However, if you use the
funds to purchase a primary residence, you may have a much longer period of
time to repay the loan.
Make sure you follow to the letter the repayment
requirements for your loan. If you don't repay the loan as required, the money
you borrowed will be considered a taxable distribution. If you're under age
59½, you'll owe a 10 percent federal penalty tax, as well as regular income tax
on the outstanding loan balance (other than the portion that represents any
after-tax or Roth contributions you've made to the plan).
What are the advantages of borrowing money from your 401(k)?
- You won't pay taxes and penalties on the amount you borrow, as long as the loan is repaid on time
- Interest rates on 401(k) plan loans must be consistent with the rates charged by banks and other commercial institutions for similar loans
- In most cases, the interest you pay on borrowed funds is credited to your own plan account; you pay interest to yourself, not to a bank or other lender
- If you don't repay your plan loan when required, it will generally be treated as a taxable distribution.
- If you leave your employer's service (whether voluntarily or not) and still have an outstanding balance on a plan loan, you'll usually be required to repay the loan in full within 60 days. Otherwise, the outstanding balance will be treated as a taxable distribution, and you'll owe a 10 percent penalty tax in addition to regular income taxes if you're under age 59½.
- Loan interest is generally not tax deductible (unless the loan is secured by your principal residence).
- You'll lose out on any tax-deferred interest that may have accrued on the borrowed funds had they remained in your 401(k).
- Loan payments are made with after-tax dollars.
Hardship withdrawals
Your 401(k) plan may have a provision that allows you to
withdraw money from the plan while you're still employed if you can demonstrate
"heavy and immediate" financial need and you have no other resources
you can use to meet that need (e.g., you can't borrow from a commercial lender
or from a retirement account and you have no other available savings). It's up
to your employer to determine which financial needs qualify. Many employers
allow hardship withdrawals only for the following reasons:
- To pay the medical expenses of you, your spouse, your children, your other dependents, or your plan beneficiary
- To pay the burial or funeral expenses of your parent, your spouse, your children, your other dependents, or your plan beneficiary
- To pay a maximum of 12 months worth of tuition and related educational expenses for post-secondary education for you, your spouse, your children, your other dependents, or your plan beneficiary
- To pay costs related to the purchase of your principal residence
- To make payments to prevent eviction from or foreclosure on your principal residence
- To pay expenses for the repair of damage to your principal residence after certain casualty losses
Note: You may also be allowed to withdraw funds to pay
income tax and/or penalties on the hardship withdrawal itself, if these are
due.
Your employer will generally require that you submit your
request for a hardship withdrawal in writing.
How much can you withdraw?
Generally, you can't withdraw more than the total amount
you've contributed to the plan, minus the amount of any previous hardship
withdrawals you've made. In some cases, though, you may be able to withdraw the
earnings on contributions you've made. Check with your plan administrator for
more information on the rules that apply to withdrawals from your 401(k) plan.
What are the advantages of withdrawing money from your
401(k) in cases of hardship?
The option to take a hardship withdrawal can come in very
handy if you really need money and you have no other assets to draw on, and
your plan does not allow loans (or if you can't afford to make loan payments).
What are the disadvantages of withdrawing money from your
401(k) in cases of hardship?
- Taking a hardship withdrawal will reduce the size of your retirement nest egg, and the funds you withdraw will no longer grow tax deferred.
- Hardship withdrawals are generally subject to federal (and possibly state) income tax. A 10 percent federal penalty tax may also apply if you're under age 59½. (If you make a hardship withdrawal of your Roth 401(k) contributions, only the portion of the withdrawal representing earnings will be subject to tax and penalties.)
- You may not be able to contribute to your 401(k) plan for six months following a hardship distribution.
What else do I need to know?
If your employer makes contributions to your 401(k) plan
(for example, matching contributions) you may be able to withdraw those dollars
once you become vested (that is, once you own your employer's contributions).
Check with your plan administrator for your plan's withdrawal rules.
If you are a qualified individual impacted by certain
natural disasters, or if you are a reservist called to active duty after
September 11, 2001, special rules may apply to you.
Give Adams Wealth Management Group at call at (866) 513-2099
for any additional questions you may have about your 40(k) plan.
The opinions voiced in this material are for general
information only and are not intended to provide specific advice or
recommendations for any individual. To determine which investment(s) may be
appropriate for you, consult your financial advisor prior to investing. All
performance referenced is historical and is no guarantee of future results. All
indices are unmanaged and cannot be invested into directly.
The tax information provided is not intended to be a
substitute for specific individualized tax planning advice. We suggest that you
consult with a qualified tax advisor.
Securities offered through LPL Financial, Member FINRA/SIPC
