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How To Access your 401(K) Funds Early

There may come a time in your life when you’re stuck between a rock and a hard place, and you need cash. What are your options? You can possibly take out a loan from a bank, though that’s not guaranteed. You can use your credit card – but we don’t recommend that if you can’t pay it off by the end of the month. Then, you consider your 401(K) – a reserve of thousands, perhaps tens of thousands, earmarked for your retirement. 

Well, hold on – why would you even consider such a thing? Withdrawing funds from your 401(K) can reduce its growth potential and may incur a 10% penalty and income tax, potentially exacerbating your worsening financial situation. 

As a matter of fact, there is the possibility of avoiding those penalties and/or taxes via two methods: 

  1. A hardship withdrawal 
  2. A loan against your 401(K)

Hardship Withdrawals

One way to avoid the 10% fee (but not the tax consequences) is with a hardship withdrawal, used to pay for an immediate, pressing, and, more importantly, qualified need. Examples of qualified hardship withdrawals include but are not limited to:
Remember two things – you’ll need to secure and store documentation proving you have a hardship in case the IRS asks for it. And two, your plan provider may not allow you to take out hardship withdrawals. It’s wise to have a safety net to avoid needing a hardship withdrawal, though we understand that unforeseen circumstances can occur.

401(K) Loans

Another way to access your 401(K) funds is to borrow against them, and in some instances, it could be a financially savvy move. In this case, you don’t need to prove any ‘hardship’ to the IRS. You can simply borrow against your 401(K) to buy yourself a gold watch (strongly don’t recommend it!). 
Of course, there’s a catch. You typically have to repay your loan within five years, plus interest and potential loan fees. The silver lining is that the interest goes into your 401(K), not your plan provider’s pocket.  But there are also some bonuses:

However, failing to pay the loan back will result in it becoming a standard withdrawal, meaning you’ll owe ordinary income taxes on it, and if you’re under 59 ½, you’ll be hit with a 10% penalty.

So, here are some valuable tips:

Remember, by pulling from your 401(K), you’re limiting its ability to grow at a compound rate, hurting your retirement goals, so exhaust other fiscally sound alternatives before executing a withdrawal.

But as we said, there may be times when it actually makes sense to borrow from your 401(K).

Pay off credit card debt (or other high-interest debt)

So, what’s your credit card rate looking like? 15%? 20%? And what does a 401(K) loan interest rate look like? It depends on your plan provider, but we’d bet the farm it’s significantly lower than your credit card’s. Generally speaking, 401(K) loan rates are about a point or two higher than the prime rate, which serves as a benchmark for establishing loan rates and is based on the Federal Reserve rate. Plus, remember that the interest rate is going into your own account, not into your banker’s.

Down Payment for a Home

This method involves some trickier math than just comparing interest rates. Pulling funds from your 401(k) for a down payment might be advantageous if the savings from a reduced mortgage—both in monthly payments and overall interest over the life of the loan—surpass the potential growth of those funds if they remained in the 401(k). 

You’ll also need to consider the opportunity cost of missing out on potential market gains, the tax implications of withdrawing from a retirement account, and the stability of having equity in a home. It’s a balancing act between short-term housing stability and long-term financial growth.

How Much Can You Borrow?

You can’t just borrow the total amount of your 401(K) (hopefully, that wasn’t your intention in any case). The IRS stipulates that the maximum amount you can borrow from your 401(k) is limited to either 50% of your vested balance or $50,000, whichever is less. Alternatively, you can borrow up to $10,000 if 50% of your vested balance falls below that threshold, depending on your plan’s provisions.

In Conclusion

In general, retirement savers should let their retirement funds be. By withdrawing funds early, whether through a hardship withdrawal or loan, you’re missing out on lost potential growth and slowing down its compounding abilities. 

However, there may be times when you simply need the cash, and you’ve exhausted every other route. If that’s the case, we strongly urge you to seek out the advice of a fiduciary financial advisor to help you determine the best course of action.

About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

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  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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