Can I Draw My Money Out of My 401(k) if I Lost My Job?
The loss of a job is a terrible blow, both personally and financially. If you're fortunate enough to have received a good severance package, however, your former employer might have bought you a bit of time before money becomes a major concern. If that's not the case, you might be tempted to tap into your retirement savings to ease you through the pinch. Although it's often possible to draw money out of a 401(k) to cover expenses, the early withdrawal will cost you. Don't touch your retirement savings until you understand your options.
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How a 401(k) Works
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A 401(k) is a defined-contribution retirement plan that an employee funds and owns. (Unlike defined-benefit pensions, which The New York Times notes are owned and funded by employers and result in a "defined benefit" -- a set amount of money -- for employees after they retire, employees themselves decide how their 401(k) contributions are to be invested and their retirement benefit amount depends on how much they've contributed and how much their contributions have earned. Many plans offer a variety of funds from which to choose, and some employers match their employees' contributions or a portion of them. Employees may, under special circumstances, begin to withdraw money from their 401(k) at age 55; however, most will incur penalties and tax disincentives unless they wait until age 59 1/2 to tap into their accounts.
Hardship
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Many 401(k) plans allow employees to withdraw money from their 401(k)s if they can prove a hardship; however, the 401(k) Help Center acknowledges that employers aren't required to make hardship withdrawals available. When hardship withdrawals are possible, the types deemed acceptable are strictly defined by law. Withdrawals typically are allowed for unreimbursed medical expenses; the purchase or repair of a primary residence; a court-ordered transfer of 401(k) funds to a spouse or other dependent; and tuition and related education expenses. If you meet one of the following criteria, you may be able to withdraw the money without penalty: total disability; medical expenses that total more than 7.5 percent of adjusted gross income; or "separation from service," which means loss of a job, whether through layoff, termination, retirement or resignation. The separation can have occurred at age 55 or later, or it can have occurred after you'd arranged to receive your 401(k) savings in equal payouts for at least five years or until you reach age 59 1/2, whichever is later. In many cases, early withdrawal requires that you not have other assets that you could use to offset the hardship.
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Penalty for Early Withdrawal
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If you don't meet any of the criteria that protect hardship withdrawals from penalty, you'll be charged a 10 percent fee on the amount you withdraw from your 401(k). Even if you do meet the criteria and avoid the penalty, you'll be taxed on the amount of your withdrawal. Tax on early 401(k) withdrawal is based on the employee's tax bracket.
401(k) Loan
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If you've already lost your job, a loan against your 401(k) isn't an option. You must be work for the employer that's holding your account in order to qualify. However, if you're still employed but are worried about losing your job and have nowhere else to turn, you probably can borrow money from your account. According to Smart Money, you're typically "allowed to borrow up to half your vested account balance," up to $50,000. Your "vested" amount is the portion of the balance to which your length of employment entitles you. The loan is repayable over five years, usually at an interest rate of 1 to 2 percent above prime. On the upside, this is interest you pay to yourself. On the downside, if you lose your job before the loan is repaid, you'll have 60 days to repay it in full or else the balance will be treated as a withdrawal and penalties will apply. Of course, if part of the loan already has been repaid, you'll pay less penalty and tax than you'd have paid had you taken the whole amount as a withdrawal.
Transfer to an IRA
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According to financial planner and CBS Money Watch contributor Ray Martin, you should consider transferring your 401(k) into an IRA if you're no longer working for your employer and can't take out a loan against your account. In some hardship situations, including those for which a 401(k) withdrawal would be subject to penalty, money can be withdrawn penalty-free, although you'll still have to pay taxes on the amount you take out. To qualify, you'll have to have have received at least three months' worth of unemployment benefits and take withdrawal in the same year you become unemployed or in the following year. For example, if you you lost your job in January 2010 and your unemployment benefit began on Jan. 15, by April 15 you had collected unemployment long enough to qualify for the penalty-free withdrawal. You could have taken the withdrawal in 2010, the year in which you lost your job, or in 2011, the following year.
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