If you need money and have been saving for retirement with a 401k plan, you may be wondering what’s better…a 401k Early Withdrawal versus Borrowing Against 401k. You may want to use the money to weather your current financial storm. If you are relatively unfamiliar with the ins and outs of 401k plans, you may be confused. Many individuals know they are saving for retirement and that is it. Do you have to repay the money you take out? Are you charged fees? It all depends because you have a couple options.
More people tapping into 401k plans for financial help
So, what are your options to access the money in your 401k account? Your options include doing a 401K Early Withdrawal and borrowing against your 401K. What is your best option?
The 401K Early Withdrawal Option:
When doing a 401K Early Withdrawal, you don’t take a percentage of it. You take it all. This may seem like a good option if you want to buy a new car and pay for it in full. With that said, you are charged penalties. This penalty is 10%. You are not charged this fee when accessing your retirement at the age of 60. Moreover, 401k contributions are tax sheltered at first. You are taxed when you access the money, such as with an early withdrawal.
Having your retirement savings in your hand to use at your disposal may seem like a good idea. Yes, it will at the time. It is important to think long-term. Say, you have $20,000 in retirement savings. After the 10% fee, federal and state taxes, you are left with an average total of $16,000. For starters, you lose money. Next, you no longer have that money for retirement. How do you intend to survive financially without it? You better have a backup plan in place. If not, you could be homeless or working until you are 70 to make ends meet.
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Not all employers have the option of early cash outs. Most advise against it. One of the few cases in which an employer will opt for an early cash out is with extreme financial distress or terminal medical conditions. The other case is with a job switch. If switching jobs, you can leave your 401k as is and pay management fees or you can rollover to an IRA or your new company’s 401k plan. There is, however, the option to cash out early. If you are in your early 20s and do not have a lot of money invested, you don’t have much to lose.
What about Borrowing against 401K?
As shown, withdrawing from your 401k has many downsides. It is risky and you lose money for retirement. If you need cash and you need it now, you may want to try borrowing from your 401k. Most employers allow them. These are loans, so they must be repaid. Although 401k loans are optional, most employers will give them if you show need. Fill out a loan application and speak to someone in your company’s financial department.
The only significant downside to borrowing from your 401k is double taxation. As with cash outs, you are taxed when you get the money. Next, you repay that loan. When repaying, you are taxed. This money is not legally considered a 401k contribution, but a loan payback. So, you are double taxed. Still, it is usually less than the fee charged with a 401k early cash out. There may also be a handling fee, usually around $75 or less.
The only dangers of a 401k loan come from changing jobs and not making repayment. If you do not repay your loan, your account may go to collections. If you change jobs, your employer may shorten the term of your loan and request payment within 90 days. If you anticipate switching jobs soon, hold off on a loan or consider waiting to make the switch.
As you can see, both 401k loans and early cash outs have their pros and cons. If you are in financial distress, take a minute to think about the situation. Have you considered the alternatives, such as getting a bank loan, borrowing money from family, reducing expenses, or getting a second job? Dipping into your 401k account, even as a loan, should only be used as a last resort.