Is it Ever OK to Take Money From Your 401(k) Early?

When you’re young, saving for retirement can seem a bit daunting. It may take you several decades before you have enough money to retire. And keeping yourself motivated to save can be tough.

If you already have a 401k, you may be tempted to use that money for something else…now. If you’re in debt, have home repairs, or need cash ASAP, taking money out of 401k funds can seem like an attractive option.

According to a 2015 article by Fidelity, eleven percent of workers took out a 401k loan within the past year, at an average amount of $9,500.

But is there really ever a reason it makes sense to make a 401k early withdrawal and use that cash for something else? Let’s take a closer look.

Using your 401k to pay off debt

Taking money out of your 401k in order to pay off debt seems to make sense on the surface.

Your debt is accumulating interest and costing you money. If you have money in your 401k to pay it off, or at least lessen your debt load, why not, right?

However, the magic behind the 401k is the compound interest — or interest on top of interest — that you would earn on your funds. And if you take money out now, you’ll have to start all over again with your investments. Plus, you could lose some of the gains you’ve already made.

Instead of taking an early withdrawal from 401k, consider making a balance transfer. You can consolidate your credit card debt using a zero percent interest credit card. Then, pay off your balance before the promotional period is up.

Another option is getting a personal loan to pay off credit card debt. If the interest rate for the personal loan is lower than your credit card’s, then you can save money on interest payments. And you avoid tapping into your retirement funds.

While paying off high-interest credit card debt with a 401k early withdrawal may seem attractive, why pay for your past with funds from your future? Though it seems like the easiest way to pay off debt, Certified Financial Planner David Rae disagrees.

“When times get tough people often make the big mistake of pulling money from retirement accounts to pay off debt, or other bills,” says Rae. “If your situation is truly dire, retirement accounts are often protected in bankruptcy or from creditors. But once you’ve pulled money out, it’s fair game.”

401k early withdrawal for emergencies

Emergencies usually happen when you least expect them, and at the most inconvenient times. Whatever the situation may be, it can be tempting to make a 401k early withdrawal to pay for them.

However, taking money out of 401k or retirement savings accounts can mean paying extra in taxes. Not to mention a withdrawal penalty.

“If you take money out of your 401k you will owe income taxes and a 10 percent penalty if you are under 59 and a half,” Rae says.

If you really don’t have the cash on hand for emergencies, you may want to consider using a credit card instead. Especially if you can pay it off before interest accrues. Or, take out a personal loan at a low-interest rate, which may take a few months or even a few years to pay back.

While these options may be better than using your retirement funds, they are still less than ideal. Cash is king. So if you don’t have any money saved up for the unexpected, there’s no better time than now to get started.

An emergency fund can be three to six months’ worth of expenses in a separate, high-yield savings account — and only used for emergencies.

401k rules for early withdrawals

After saving your hard-earned money for your future, it may seem like no big deal to borrow money from your retirement account. It is your money after all.

But there are real consequences to a 401k early withdrawal. As noted above, taking money out of 401ks can lead to a penalty fee of 10 percent as well as additional income taxes.

Not only that, it may be harder to get back on track once you’ve borrowed. Last year, Fidelity noted in its analysis that half of investors who borrowed from their 401k ended up borrowing more later on.

Aside from these 401k rules, you also want to make sure you like your job and plan on staying awhile as you pay back your 401k loan. Typically, you need to repay your balance within two months of leaving the company who offers the retirement plan.

If you think you are at risk of being laid off, taking on a 401k loan could be too risky.

Avoid 401k early withdrawals at all costs

“I really don’t think there are very many scenarios when pulling money from your 401k makes sense,” says Rae. “If you are able bodies and working you really should explore other options.”

In other words, tapping your retirement funds should be an absolute last resort. Try and look into using your savings, credit cards, or other types of loans first before touching your 401k.

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1 Includes AutoPay discount. Important Disclosures for SoFi.

SoFi Disclosures

  1. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Finance Lender Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)
  2. Personal Loans: Fixed rates from 5.49% APR to 14.24% APR (with AutoPay). Variable rates from 5.29% APR to 11.44% APR (with AutoPay). SoFi rate ranges are current as of December 1, 2017 and are subject to change without notice. Not all rates and amounts available in all states. See Personal Loan eligibility details. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your credit worthiness, years of professional experience, income and other factors. Interest rates on variable rate loans are capped at 14.95%. Lowest variable rate of 5.29% APR assumes current 1-month LIBOR rate of 1.34% plus 4.20% margin minus 0.25% AutoPay discount. For the SoFi variable rate loan, the 1-month LIBOR index will adjust monthly and the loan payment will be re-amortized and may change monthly. APRs for variable rate loans may increase after origination if the LIBOR index increases. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account.

2 Important Disclosures for Citizens Bank.

Citizens Bank Disclosures

  1. Personal Loan Rate Disclosure: Variable rate, based on the one-month London Interbank Offered Rate (“LIBOR”) published in The Wall Street Journal on the twenty-fifth day, or the next business day, of the preceding calendar month. As of August 1, 2017, the one-month LIBOR rate is 1.23%. Variable interest rates range from 6.02% – 15.97% (6.02% – 15.97% APR) and will fluctuate over the term of your loan with changes in the LIBOR rate, and will vary based on applicable terms and presence of a co-applicant. Fixed interest rates range from 5.99% – 16.24% (5.99% – 16.24% APR) based on applicable terms and presence of a co-applicant. Lowest rates shown are for eligible applicants, require a 3-year repayment term, and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.
  2. Loyalty Discount: The borrower will be eligible for a 0.25 percentage point interest rate reduction on their loan if the borrower has a qualifying account in existence with Citizens Bank at the time the borrower has submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, student loans or other personal loans owned by Citizens Bank, N.A. Please note, Citizens Bank checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI and VT. This discount will be reflected in the interest rate and Annual Percentage Rate (APR) disclosed in the Truth-In-Lending Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan, and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan.
  3. Automatic Payment Benefit: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their student loans owned by Citizens Bank, N.A. during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. Discount is not available when payments are not due, such as during forbearance. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account three or more times within any 12-month period, the borrower will no longer be eligible for this discount.
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