401k Early WithdrawalWhen the economy is such a turmoil, it can be hard to make ends meet.   You may be scrambling to find extra money to pay all of your expenses.   You’re in a financial pinch and you’re running out of ideas.

It’s times like these that a 401k early withdrawal may seem like a good idea, but is it?   Is your 401k your best source for extra funds? Tapping into your 401k for extra funds is not always your best choice.

Early withdrawals from your 401k are not always the cheapest way to get extra funds either.   With early withdrawals from 401k plans you incur 401k taxes and penalties;  taxes and penalties can get expensive.

What happens with a 401k early withdrawal:

#1 – What is considered an early 401k withdrawal?

  • A withdrawal before you turn age 59 1/2 is considered by the IRS to be an early 401k withdrawal.

#2 – What is not considered a 401k early withdrawal?

  • When you change jobs and roll over your 401k balance to a new employers 401k plan or an IRA.
  • A retirement distribution (if after age 59 1/2)
  • 401k  loans, that are paid back.

#3 – What happens when you make a 401k early withdrawal?

  • You will pay 401k taxes.
  • You can pay penalty fees of 10%.

#4 – When can you avoid taxes on a 401k early withdrawal?

  • Withdrawals after age 59 1/2.

#5 – When can you avoid penalties?

  • At death.
  • 401k loans; unless you do not pay the loans back.
  • If you are under age 591/2 and you do not pay back the 401k loan, the IRS considers that loan an early withdrawal.
  • The IRS counts that loan as income for the year of the withdrawal.
  • You will be taxed and pay a 10% penalty on the amount of the withdrawal.
  • If you are over age 59 1/2 at the time you take out the loan, you do not have to pay the loan back.

#6 – Is there a better way to tap into your 401k plan?

  • A 401k hardship loan can be a better option, if you qualify.

#7 – When can you take a 401k hardship loan?

  • 1st time home buyer.
  • Un-reimbursed medical expenses.
  • Higher education expenses.
  • Payment to prevent eviction from your home.
  • Funeral expenses

#8 – Are you restricted on how to spend the money from a 401k hardship loan?

  • The money has to be used for a financial hardship.
  • You cannot buy a boat or a flat screen television….those are not considered by the IRS to be financial hardships.
  • You cannot roll over the money from a hardship loan into an IRA, 401k or other qualified retirement plan.

So in tough times, you do have options.   You can take an early withdrawal from your 401k plan, if you are willing to pay taxes and a 10% penalty.    But why pay taxes and tax penalties when you dont’ have to.    You can take a 401k loan and all you have to pay is the interest, unless you do not pay the loan back.   With a loan, you don’t have to pay taxes or penalties, if you pay the loan back.

When you are in a financial pinch, your best option may be to find another source of funds besides your 401k plan.   If you are uncertain though about your best options in a financial bind, talk with your financial adviser.  When in doubt – check it out.