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The Real Cost Of Tapping Into Your 401(k)

The Real Cost Of Tapping Into Your 401k

While accessing the funds in 401(k) accounts isn't impossible, it's highly advised against -- and for good reason. According to Forbes, tapping into that money should only occur if there's an "immediate and heavy financial need." In other words, it should be considered as a final resort, not an emergency savings account.

And the reasons aren't that complicated. For one, penalties and taxes generally apply, even for hardship distributions. For another, that money has been set aside for a specific purpose; early access disturbs the financial security of you and your loved ones' future.

When Tapping Should Be Considered

However, there are always exceptions.

A 401(k)s is not typically prohibited; major, unplanned financial life events happen, and common enough to where exceptions can be made.

For instance, penalties can be dismissed if the early withdrawal is specifically for medical care that exceeds 7.5 percent of your adjusted gross income (if the expenses are paid same year).

Related Link: 5 Myths About The 401(k)

Similarly, hardship distributions can be made if there imminent foreclosure proceedings (on the primary residence). Also home related, necessary home repair caused by acts of God (qualifying damages by Internal Revenue Code section 165) can be approved as well.

One other area of life that can incur high costs unexpectedly and unavoidably are final arrangements. Hardship withdrawals for necessary funeral expenses (burial, memorials; not flowers or receptions) can be approved.

While other instances might receive approval (secondary education expenses, first home buying), and it is always recommended to ask about penalty/tax exemptions, these three instances are the most justifiable for accessing 401(k) savings.

Why Tapping Is Frowned Upon

  • The Terms And Conditions Can Be Tricky: Loans and distributions are not the same. Furthermore, all distributions are not equal. Generally speaking, taxes are not incurred on 401(k) loans (unless they are not repaid in a timely manner); however, most distributions come with a lovely income tax, due on the distribution. Additionally, early withdrawals often come with a penalty, particularly for account holders under the age of 59.5. One final caveat: If the account holder leaves the employment that the 401(k) is through during the course of a loan repayment period, the balance often becomes immediately due.
  • Related Link: 9 IRA FAQs: Invest In Yourself, Educate Yourself

  • Withdrawal Penalties Are Often Convoluted: Withdrawals are subject to taxes. For example, if you have an expense of $15,000 and are in the 25 percent tax bracket, the tax liability necessitates a withdrawal of $18,750, not $15,000. When in a hardship position, that extra $3,750 can be astronomical.
  • 401(k)s Are Set Aside For A Reason: By tapping into that specific account, you diminish the integrity of the account. As stellar as your good intentions are to refurbish the money (and then some) to make up for the withdrawal, studies have shown that in light of the retirement readiness epidemic, replenishing withdrawal amounts in full is unlikely.
  • As with all things financial, particularly regarding later stages of life, one of the most difficult aspects of maintaining financial stability is understanding the basics. Without knowing how particular retirement accounts work, naïve misuse can be perilous for years to come. Acknowledge that retirement financing is different from financing for other areas of life or demographics and accept the implications and personal responsibility.

    Invest in the financial security of your future and the future of your loved ones. Talk with a financial advisor today.

    Posted-In: 401(k) Forbes IRA retirementEducation Be Your Own Boss Personal Finance General Best of Benzinga


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