Can I Take Money Out of My 401(k) for Emergencies?
When facing a financial emergency, your 401(k) retirement funds might look like a tempting bailout source. It's difficult to touch your 401(k) before you near retirement age, but depending on your individual plan, certain situations do permit you to make an emergency loan or permanent withdrawal. Just because you can doesn't mean you should, however. In most cases, taking money out of your 401(k) should be a last resort.
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Requirements
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The U.S. Internal Revenue Service allows you to withdraw hardship funds from your 401(k) only for certain purposes: medical costs, home costs, tuition, money to prevent eviction or foreclosure, funeral expenses or repairs for damage to your home. Your employer will have its own restrictions on emergency withdrawals or loans, which your human resources department can explain. More than 90 percent of 401(k) plans allow you to use funds for emergencies, according to Bloomberg Businessweek, but you will have to prove the emergency and that you have no other sources of money to cover it.
Types
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Some 401(k) plans allow loans. Most of these loans come with low interest rates and can be paid off over five years. Your limits vary by plan, but often you can take no more than 50 percent of your investment or $50,000, whichever is less, according to USA Today financial columnist Sandra Block. Your other option is a withdrawal, which you will not have to pay back but almost always will come with taxes and penalties. Either way, your plan probably will limit your withdrawal to the specific amount you need for the emergency.
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Effects
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Because a 401(k) consists of money taken out of your paycheck without taxes, the IRS usually charges you both the taxes on a permanent withdrawal plus a 10 percent penalty on those taxes. The IRS will waive the penalty in a few cases, such as if you become permanently disabled or if your medical costs total more than 7.5 percent of your adjusted gross income. With a loan, you avoid taxes and penalties as long as you do not default. If you lose or leave your job, you must pay off that loan in full within a few months or face the taxes and penalty, according to Block.
Considerations
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Taking money out of your 401(k) allows you to put out a financial fire, but you also should consider whether the damage to your retirement savings is worth it. If the money is to avoid foreclosure, for example, you should evaluate whether it will permanently solve the problem or merely provide a temporary fix, leaving you in the same situation a few months later. Also, if you find yourself in foreclosure or bankruptcy, your 401(k) is immune from creditors, so you are withdrawing money that otherwise would be protected.
Warning
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Besides penalties and taxes, you have plenty of reasons to avoid raiding your 401(k). Even in loans you ultimately pay back, you lose the gains that money would have generated over the years. Your 401(k) plan also might have rules that ban you from contributing to it up to a year after a withdrawal. Block also cautions that withdrawals often require you to disclose potentially embarrassing personal information to your plan administrator in order to prove the hardship.
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References
- IRS.gov: Retirement Plans FAQs Regarding Hardship Distributions
- Bloomberg Businessweek: Tapping your 401(k) in an Emergency
- TurboTax: Withdrawing Money From Your 401(k) Plan as a Hardship Distribution
- 401k Planning: What are the 401k Withdrawal Penalties?
- USA Today: In a Terrible Bind? Tapping your 401K May Not Be Smart
Resources
- Photo Credit David Sacks/Lifesize/Getty Images
