As you are undoubtedly aware, tapping into your 401(k) fund before you retire can have a serious and potentially devastating impact on your financial future. If you feel that circumstances warrant an early withdrawal, you should make sure that you are aware of the options available to you and the risks that they carry.
Hardship Withdrawals: For Emergency Purposes Only
If you are hit with a financial hardship, like a death in the family (the average funeral in the United States costs upwards of $6,000) and find yourself with little or no financial recourse, make sure that you understand the terms of your 401(k) loan or Hardship Withdrawal carefully before signing, and remember that the decision to exercise these options is not one to be taken lightly. Generally, you should be able to make hardship withdrawals from your 401(k) for emergencies such as:
- Medical Expenses
- To Pay College Tuition
- Funeral Expenses
There may be other extenuating circumstances but please consult your company’s benefit’s department for details. When you make a hardship withdrawal, you will have to pay, the very least, a 10% penalty for early withdrawal, in addition to income taxes on the amount of money that you withdraw. You may also be unable to contribute more money into your account for up to six months after the withdrawal. For these reasons alone, hardship withdrawals should only be considered when no other option to acquire emergency funds exists.
Loans: Borrowing From Your Future Self
This may sound like the plot of a science fiction movie, but in actuality, loans on your 401(k) do essentially equate to borrowing from your future (retired) self. You are typically allowed to borrow up to half of what you have been invested, as long as your total contributions do not exceed $50,000. This may sound like a viable option, but most financial planners will tell you to exercise it with caution, since the purpose of a 401(k) is to secure funds for retirement and if you become unable to repay your loan on time, you face stiff penalties that can further deplete your retirement savings.