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If you have a sudden expense and need to withdraw funds from your 401(k) account, you should have an idea of the kind of penalties you’ll be incurring. Let’s discuss the ins and outs of the plan’s withdrawal rules, and determine how you can make them work best for you.
How They Work
It should be noted that different 401(k) plans have different rules for withdrawal, but there are usually commonalities. Almost all employers impose severe restrictions on employees who access their plan prematurely, and the federal government has a hand in setting policy.
Any withdrawal made before the age of 59 ½ is subject to an excise tax of 10% of the sum cashed out, with some small allowances made for money withdrawn to pay for medical care. Aside from the skim off the top, the money you withdraw is taxed at the regular rate for all earnings: it’s no longer exempt.
Reasons for early withdrawal factor into the penalties; these are called hardship clauses. They include a death in the family, an illness, or massive property damage – but some or all of these may be dismissed by your employer. In order to go through with your withdrawal, it’s possible that you may have to quit your job.
Depending on your plan, you may be able to arrange for a loan based on your 401(k), to be repaid according to an interest rate determined by your employer’s benefits package. The resulting loan won’t be taxable by the excise rate of 10%, providing it’s paid back on time.
Benefits
401(k) plans can add up over the years, and if you have to face an unforeseen crisis in middle age, there may be a substantial sum available to you this way. It’s money you may have forgotten about that can be accessed only when you need it most.
Pitfalls
As already mentioned, there are pretty steep penalties for withdrawing before you’re of age to retire, and depending on your employer, they can get even steeper. In the worst case scenario, you can lose almost 20% of the total sum – and it can even mean having to resign.
Conclusion
Withdrawing your 401(k) contributions may be crucial in a crisis – it can help you overcome a temporary setback or weather the storm until you’re back on your feet. After all, it’s yours, and you should take it if you need it. Just remember: it’s rainy day money, so if you’re spending it, make sure it’s raining.
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