Should you tap into your 401(k)?

Thinking about tapping into your 401(k) plan? Think twice.

While a 401(k) plan isn’t designed for us to freely tap into it, the fact remains many individuals are turning to their 401k plans in the time of need.  According to a survey conducted by TIAA Cref, nearly 1/3 of individuals have taken a loan from their retirement account. Not only are individuals taking out loans, but some are simply withdrawing the funds to make ends meet.

Qualifying for a hardship withdrawal

If you desire to withdraw money from your 401k plan, it has to qualify for a hardship.  An individual would qualify if they need the funds to pay medical expenses, purchase a primary home, pay for burial expenses for a loved one, or make repairs to your home.  However, keep in mind, while you may be able to tap into your plan for these types of hardships, tapping into your plan will cost you.

A withdrawal made prior to the age 59 ½ is subject to an additional tax penalty of 10%.  Also, you are required to pay income tax on the money received.  So, let’s say you decide to withdraw $10,000 from your retirement plan and you’re currently in the 25% tax bracket, not only will you pay $2,500 in taxes but you may also be required to pay a penalty of $1,000 tax penalty, leaving you with only $6,500!

Borrowing against your funds

Individuals may borrow up to 50% of the vested amount up to a maximum of $50,000.  The amount borrowed must be repaid within 5 years. The term could be longer in the event the funds are used to purchase a home.  Keep in mind, while you are not subject to taxes or penalties for borrowing funds, if you separate from your place of employment the balance will become due.  Failure to pay the amount in full could result in an additional tax penalty of 10% and income and state taxes.

Try to avoid it at all cost

If you are thinking about tapping into your 401(k) plan, try to avoid it at all cost.  In the event that you simply cannot, consider borrowing against the plan versus withdrawing funds.  This will help save on additional taxes and avoid reducing the amount you get because of penalties and taxes.  Try to exhaust all other resources. Consider borrowing from family or friends.  Understand money taken from the plan could greatly reduce your retirement in the future.  Implement a savings plan to keep retirement accounts off limits.

Kemberley Washington is a certified public accountant and professor at Dillard University.  Check out her Ebook, Let your budget inspire you!

 

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