FINANCE
How to take a 401(K) loan and why it’s not a good idea
Why it is not a good idea to take money out of your 401(k) before you retire.
The beauty of a 401(k) is that a worker can put away money that collects interest throughout their career, and then when it comes time to take those funds out, a tax is levied against the payment. A ROTH IRA, on the other hand, taxes funds as they go into the account but not as they come out.
The advantage of a 401(k) is that since taxes aren’t being applied as the funds go in, more money is placed in the account, and therefore, the greater amount that ends up in the account has more time to compound in value. This year, workers with a 401(k) can put a maximum of $23,000 into their accounts. These funds are subtracted from their taxable income, which can help reduce one’s tax bill if putting away a certain amount places the filer in a lower tax bracket. However, in both cases, there are penalties if funds are taken out as a loan to one’s self rather than used when a worker retires.
When is the earliest you can take out funds?
For those who withdraw funds from their 401(k) or ROTH IRA before they turn 59.5 years old, a 10 percent distribution fee could be applied to the sum they are attempting to withdraw. This fee must be paid in addition to the taxes the IRS would have levied against the payment when it was taken out, regardless. Increasing the cost of taking out the money early works to disincentive people from taking money out before they retire. However, there are certain cases where funds can be withdrawn without paying the penalty. The IRS has published a full list of the justifications that can be used to avoid paying the heft fine.
- Age
- Automatic enrollment
- Birth or adoption
- Corrective distributions
- Death
- Disability
- Disaster recovery distribution
- Domestic abuse victim distribution
- Domestic relations
- Education
- Emergency personal expense
- Emergency savings account
- Equal payments
- ESOP
- Homebuyers
- Levy
- Medical
- Medical
- Military
- Returned IRA contributions
- Rollovers
- Separation from service
- Terminal illness
- Unemployed health insurance
Funds in a ROTH IRA can cover “qualified higher education expenses” and pay health insurance premiums while experiencing unemployment. One of the more recent justifications, which came into effect last year, allows survivors of domestic abuse who have evidence to substantiate their claim to receive up to $10,000 or fifty percent of the retirement account.
To take out funds you will need to contact the organization that manages your retirement account. Sometimes, these processes are automated, but in the case you are looking to avoid paying penalties, you will likely need to provide some evidence that could extend the time it takes to receive your funds.