Withdrawing Money from my 401k Plan – Is it Advisable? How Much Can I Withdraw from my 401k Plan and How do I repay?

If you have been diligently saving a 401k plan for retirement, you know how important it is to preserve your capital so that you can have enough money for the time when you will need it the most and the time when you stop working; your retirement! Many people wonder whether withdrawing money from my 401k plan is a good idea or not. Obviously the drawbacks are that you are taking money out and are risking having little or no money left for retirement. You could also face stiff penalties for withdrawing money from your 401k plan before the age of 59 and ½, precisely a 10% early withdrawal penalty. The image on the left shows long term financial planning, the cartoon at the very top with hands up high is the one that has stuck with his 401k plan for the long term, and not reacted to taking 401k withdrawals or loans. Supposedly, the person at the very bottom has not had a long term view of retirement and took 401k loans, hardship withdrawals and stock market losses.

However, if you are facing a financial need for which you urgently need money such as sudden medical expense, college tuition fees for your kids, attorney fees, lawsuit or any other emergency, then you have no option but to tap in to your 401k plan and withdraw money from it.

It is important to check with your Human Resources department to make sure you are eligible to withdraw money from your 401k plan because some companies do forbid it. You could either phone your plan administrator or read your plan summary description. Most employers will allow you to withdraw money from your 401k plan if you are facing financial hardships. Here are some characteristics of 401k withdrawals for financial hardships:

401k loans require little paperwork or 100% online electronic records.

No credit check is conducted on 401k loan applications.

Little or no processing fees

How Much Can I Withdraw from my 401k Plan?

You can borrow a maximum of $50,000 or of 50% of your vested 401k contributions, whichever is lesser. If your account value is only $20,000, then you can borrow up to half of it ($10,000) towards your financial hardship.

How do I repay my 401k Loan?

Repayments of money borrowed from 401k plans must be made within 5 years of initial borrowing by making regular payments of principal + interest. These payments must be made at least quarterly in the year, usually through biweekly payroll deductions. The only time this 5 year period is extended is if you are using the funds to purchase your primary residence, check with your plan administrator on how many years you have to repay your loan.

Be sure you are making quarterly payments towards your loan otherwise the money borrowed will be considered a taxable distribution and will be included as part of your net income for the year. What’s worse is that if you are 59 and ½ years or under, you will be assessed a 10% penalty as well as regular income tax on the outstanding borrowed balance.

Advantages of Borrowing Money from a 401k Plan

No taxes or penalties will be owed on the loan if it is repaid within the 5 year time limit.

Interest rates charged on 401k loans must be in line with the rate that banks charge on loans.

The interest payments you make are made to yourself, not to a bank or credit institution.

Disadvantages of Borrowing Money from a 401k Plan

If you do not repay your loan, it will be treated as a taxable distribution and included in your taxable income for that year.

If you leave your current employer with whom you have a 401k loan outstanding, you will be required to repay the entire loan in 60 days, even if you left voluntarily or were evicted.

If the loan is not repaid in regular intervals, there is a 10% penalty in addition to regular income taxes owed on the distributed amount.

You will lose out on any tax deferred interest that you would have made if your had not borrowed money from your 401k plan.

Loan repayments must be made in after-tax dollars.

What Financial Hardships are permitted?

If a 401k withdrawal is made without a legitimate financial hardship such as the ones from below, a 10% early distribution penalty is assessed and the amount is included in income as taxable income. The exceptions to this policy are:

You die and your account is paid to your beneficiary

You are fired from your job and are 55 years or less.

You begin receiving substantially equal periodic payments

Your withdrawal is due to a qualified domestic relations order (QDRO) if you are undergoing a divorce.

You become disabled and unable to work.