Penguin Pick of the Month: 401k Hardship Withdrawals
After a series of unexpected expenses, Charlie’s feeling the pinch of financial hardship. Always the prudent penguin, he wants to avoid racking up high-interest credit card debt so he started researching other ways to improve his cash flow. Then he remembered that he had money stashed away in his employer’s 401k plan and wondered if those funds could help him now. After some digging, he learned that it’s not a simple yes or no answer.
Here’s what you need to know about 401k hardship withdrawals:
- Your 401k balance can help you get out of a real jam: The IRS only allows you to take hardship withdrawals from your retirement plan if you have an “immediate and heavy” need such as covering medical expenses, buying a principal residence, repairing a principal residence, preventing eviction or foreclosure, paying for a funeral, or paying tuition and fees. Other reasons aren’t permitted.
- You can only take out what you truly need: For example, if you’re paying for college, you’ll get just enough to cover that semester’s tuition bill.
- There’s an immediate cost to access the money: You’ll have to pay income tax on the funds taken out and you could get hit with an early withdrawal penalty and an extra 10% tax.
- Tapping your 401k has long term ramifications: The money you take out will never have the chance to grow due to investment gains and compound interest. Further, your retirement plan may bar you from contributing for six months after the withdrawal. This withdrawal permanently reduces your account balance and ultimately could delay your retirement.
- Withdrawing from your 401k should be a last resort: Since a hardship withdrawal can be difficult to obtain and has lasting negative effects on your finances, you should seek out alternatives. For example, a Roth IRA allows you to access the principal balance on a tax and penalty-free basis. A personal loan or other low-interest credit line could also be a better bet.
The bottom line?
Using funds from your 401k during hard times may be appropriate, but you should try to avoid it at all costs.
Tell Charlie: Have you ever taken a hardship withdrawal from your 401k?