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:
- A hardship withdrawal
- A loan against your 401(K)
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)
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 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.