3 Money Benefits From Your 401(k) You Can Use Before You Retire
Written by
Gina Hagler
Edited by
Nicholas Morine
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Saving for retirement with a 401(k) is a popular idea because it makes it possible for you to put money aside and defer taxes on any gains until you withdraw the funds upon retirement. This is generally viewed as a positive aspect of a 401(k), as it is assumed your income after retirement will be lower than your income during your prime earning years. With those lower earnings will come a lower rate. Combine tax considerations with an employer match, and a 401(k) looks pretty good.
But what if you need some of that money before you retire or reach age 59.5? The welcome news is that you are able to have the use of your retirement funds in some circumstances. Here are three 401(k) money benefits you can use before you retire.
Benefits You Can Tap Before Retirement
- Loan from your 401(k). Many employers make it possible for you to borrow from your 401(k) without paying a 10% penalty or taxes on the money withdrawn. However, you must repay the amount you borrowed with interest within five years. Also, the amount you can borrow depends upon the provisions your employer has made as part of the plan, although there are IRS guidelines for loans, according to SmartAsset Advisors. To be sure a loan is in your best interests, familiarize yourself with the provisions of your 401(k), read what the IRS has to say about what you should consider and consult a financial advisor for advice tailored to your individual case.
- Hardship distributions. Some plans include a provision for employees to take a distribution from their 401(k) to meet a hardship. According to the IRS, the distribution can only be “due to an immediate and heavy financial need.” The distribution amount is “limited to the amount necessary to satisfy that financial need.” Finally, taxes must be paid on the amount withdrawn. There may also be a 10% penalty. Among the hardships that qualify with the IRS are medical care expenses, payment to prevent eviction and funeral expenses. Familiarize yourself with the provisions in your 401(k) before requesting a distribution.
- Early withdrawals. If you withdraw money from your 401(k) before you turn 65, or earlier if your plan defines retirement age as earlier than 65, you will pay a fine of “10% of the amount of the withdrawal. IRA withdrawals are considered early before you reach age 59.5,” according to the IRS. Taking an early withdrawal is the same as taking a withdrawal, with the only difference being that you will likely be subject to a withdrawal penalty.
Additional Considerations
The three benefits mentioned above are not all created equal. A loan from your 401(k) must be repaid with interest while meeting the terms of your 401(k). A hardship distribution may or may not incur a penalty, but you must pay taxes on the distribution because you do not need to put the money back into your 401(k). Early withdrawals also do not require repayment, but you will pay a fine — and you will pay taxes on the amount you withdraw.
An additional consideration is that the money in your 401(k) has been set aside, perhaps with an employer match to fund it, so that you can benefit from earnings on your earnings over the course of your investment timeframe. Even if pay back the amount you take with interest, removing money from your 401(k) will affect your total return.
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