Cashing Out and Borrowing from Retirement Accounts

If you are like most people, your 401(k) account represents your largest savings account. When you need to access funds in a personal financial crisis, it’s understandable why you may consider borrowing from your 401(k) account or withdrawing from your 401(k) or IRA. After all, it’s your own money, and, in the case of a loan, the interest paid goes into your retirement account. But, before proceeding with this, you should understand how borrowing from your 401(k) works and make sure that you understand the options. Borrowing or withdrawing from your retirement account prematurely should only be done when there really isn’t another option.

If you are still working for your employer, you likely have the option to borrow against your 401(k). There are a few negatives that must be considered before you choose this option.

  • Withdrawing from your 401(k) means that you are missing out on any potential gains in your account.
  • Many plans prevent you from contributing while you have an outstanding loan.
  • Repayments must be made with after-tax dollars, while the original contributions were made with pre-tax dollars.
  • If you quit your job or are laid off while your loan is still outstanding, you will have to repay the loan immediately, or it will be considered a withdrawal. With a withdrawal, you will be accessed a 10 percent penalty and be required to pay taxes.

If you have Individual Retirement Accounts (IRA), you aren’t able to take a loan from them. IRA owners can withdraw money at any time with a penalty; however, there are some exceptions that govern when you can withdraw your money penalty free. Some of these include:

  • Some higher-education costs can be paid with penalty-free IRA withdrawals; however, you still have to pay taxes on the money.
  • First time homebuyers can withdraw money with no penalty, up to a limit of $10,000.
  • Certain medical expenses can qualify you for a no-penalty withdrawal.
  • Once you are 59 ½ years old you can make withdrawals with no penalty for living expenses.

Keep in mind–with both withdrawals and loans, you will be missing out on any gains in the market if you take your money out prematurely. It can take quite a bit of time to recover, so you should consider using these two accounts for anything other than retirement only in an emergency.

Jesse Campbell photo.

Jesse Campbell is the Content Manager at MMI, with over ten years of experience creating valuable educational materials that help families through everyday and extraordinary financial challenges.

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