401K Early Withdrawals

If you have money invested in a 401K plan, you are probably aware that there is a penalty for early withdrawal before age 59 ½. Maybe your work hours or pay have been cut, and you have those pesky bills to pay, so a little bit of money pulled out early here and there won’t hurt, right?

You may want to think again if considering early withdrawal.

Here’s why:

For starters, you’ll be paying an additional 10% in withdrawal penalty fees on top of whatever else you’d pay in taxes. For example, if you use the funds to purchase something, such as $15,000 for a new roof in a state with 5% income tax, and you’re in the 20% bracket, you’d be shelling out $1,500 for the penalty, $3,000 for the federal income tax and $500 for state tax. That leaves you with a grand total of $10,000 for that roof. Ouch.

A better alternative to early 401K withdrawal would be to keep an emergency fund equal to at least 3 months’ worth of normal living expenses in case of sudden unemployment or other financial emergencies. This takes some discipline to stash away money over time on a regular basis, especially if it means putting off a vacation or replacing the car, but you may be glad you did.

Conversely, if starting a new job, (and if you’re lucky enough to find work for a company that still offers 401Ks and other benefits!) you might want to leave your current 401K alone; you can, of course, roll it over, as long as you don’t make withdrawals before the minimum age.

Other alternatives might include opening a 0% credit card line or a personal IRA. These should be done in advance if you think you’ll need a source of quick, low or no penalty funds. Even if retired it’s not too late to start saving; something is better than nothing.

But what happens if you’ve lost your job, have gone through your regular savings and there’s nothing left but that 401K? If you think you’ll have a realistic chance of paying back what you withdraw within the 5-year repayment limit (with a borrowing maximum of $50,000) then that’s what you may need to do, especially if it’s the only thing standing between a foreclosure or bankruptcy. You’ll really be repaying yourself, and if you can do this within the 5-year window, you’ll pay no penalties. Meanwhile you can’t make additional contributions until the loan is fully repaid.

Saving in this present economy can be a challenge, especially with gas prices, housing, groceries, and everything else on the rise. As long as you’re earning enough to pay normal living expenses each month, a portion of whatever is left should be deposited either in some savings vehicle, such as that 0% card account, which will carry minimal tax and other penalties if you should suddenly need to tap into it. Better safe than sorry.

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