There are times in life when a financial emergency strikes without much warning. Even if you have a savings account with a modest sum, it may not be enough to cover the sudden expenses you’re facing. A common alternative that many people consider is to either withdraw or borrow from their 401k accounts. While these may seem like attractive options, it’s essential to consider what taking either of these actions will mean for your future.
Taking a Hardship Withdrawal
One option to consider is to take a hardship withdrawal from your 401k account, which results in a payout that you won’t have to repay. Some plans also allow for withdrawals that aren’t based on hardships, so you should check with the plan administrator to learn more about your plan’s specific terms. When you take a hardship withdrawal, it’s important to note that the IRS restricts what qualifies as a hardship. These hardship situations are limited to a home foreclosure, tuition repayment, or some medical expenses. If you take a 401k withdrawal, you should be aware that you won’t receive the full sum you request. A 10% early withdrawal penalty fee and income taxes will be deducted upfront on any amount you take out of your 401k account.
Borrowing From Your 401k
Another alternative is to borrow against your 401k account. In this option, you can borrow up to half of your account balance, but you’re also limited to borrowing up to $50,000 in 12 months. You’ll be required to repay the loan and interest in full within five years. On the upside, you won’t be subjected to early withdrawal penalties or income taxes when you borrow. Additionally, the interest you pay on a loan is yours, and it’s contributed to your 401k investment account.
While borrowing from your 401k account may seem like the best alternative, you should always explore other options first. It may be better to take a small personal loan from your bank, use a credit card, or take out a home equity line of credit. When you borrow from your 401k, you’re taking money that would be better used to help you grow your retirement wealth. Since it will take you up to five years to repay the borrowed sum, that’s five more years you’ll need to save for your retirement.