Why He Doesnt Recommend You Do An Early Withdrawal
Looking back, Nitzsche says that liquidating his 401 to pay off credit card debtis something he wouldnât do again.
âIt is so detrimental to your long-term financial health and your retirement,â he says.
Many experts agree that tapping into your retirement savings early can have long-term effects. It can put you at risk later on in life when you are older, not working and would otherwise need to rely on those funds.
There are also short-term effects from making an early withdrawal from your 401 as well: It doesnât come free. Doing so has costly consequences, including both a penalty fee and taxes. For borrowers 59½ years old and younger, there is generally an early withdrawal penalty of 10%, plus taxes, which can be anywhere from 20% to 25% depending on your income and tax bracket.
If you are someone who is cash-strapped during this time of uncertainty, tapping into your retirement savings is an option of last resort. âThat really should not have been touched and not something we would usually advise somebody to do,â Nitzsche says.
What To Know If You Want To Take The 401 Loan
It is important to completely understand the rules of taking a loan from your retirement fund before you make that decision. For instance, how much can you take out? Rules may differ per plan, but its often around 50 percent of your vested balance with a max of $50,000. Youll probably be required to repay the loan in full if you leave your job. You should also know the interest rates and approximately how long you have to repay the loan.
Another big factor at play: creditor protection. Retirement accounts and pensions often come with creditor protection unless the creditor is a government entity such as the IRS. If you think youre at all at risk of filing for bankruptcy, do not raid your retirement account to pay off debt.
Read Also: Can The Irs Take My 401k If I Owe Taxes
What Are The Costs Associated With 401 Loans
You may be able to avoid paying an early withdrawal penalty and taxes if you borrow from your 401 instead of taking the money as a distribution. But 401 loans have their own set of rules and costs, so you should be sure you know what youre getting into.
There are some appealing advantages to borrowing from a 401. For starters, if your plan offers loans , you might qualify based only on your participation in the plan. There wont be a credit check or any impact to your credit score even if you miss a payment. And borrowers generally have five years to pay back a 401 loan.
Another plus: though youll have to pay interest , the interest will go back into your own 401 account not to a lender as it would with a typical loan.
You may have to pay an application fee and/or maintenance fee, however, which will reduce your account balance.
Of course, a potentially more impactful cost to consider is how borrowing a large sum from your 401 now could affect your lifestyle in retirement. Even though your outstanding balance will be earning interest, youll be the one paying that interest. Until you pay the money back, youll lose out on any market gains you might have had and youll miss out on increasing your savings with the power of compound interest. If you reduce your 401 contributions while youre making loan payments, youll further diminish your accounts potential growth.
There may be similar consequences if you default on a 401 loan.
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Should You Use A 401 To Pay Off Debt
In some cases, it could be beneficial to cash out a portion of your 401 to pay off a loan with high rates. For debts with lower interest rates, such as a home mortgage or student loan, taking a 401 withdrawal, and paying both income taxes and a possible 10% penalty on it, would make little financial sense.
Thats especially true when you consider that youd be sacrificing $45,000 in retirement savings, plus future earnings on that money.
Fortunately, there are some alternatives:
- Negotiate your interest rate: If you have good credit, then you may be able to get your interest rate lowered by several percentage points just by negotiating with your credit card company.
- Balance transfer: You can also transfer credit card balances to lower-interest credit cards. Many balance transfer credit cards have promotional periods during which they charge 0% interest, but watch out for transfer fees.
- Consolidation: If you have private student loans, consider consolidating them into a loan with a lower interest rate if your credit has improved since you first borrowed.
Youll Have To Adjust Your Budget If You Take A 401 Loan With Retirement Savings
If you dont have another option for your debt but are wary of withdrawing from your retirement savings, you may consider a 401 loan.
- Limitations: Up to 50% of savings or $50,000 , in a 12-month period. Some plans dont allow 401 loans.
- Payback: Within five years and with interest, which goes into the 401 if you leave your job, you must pay back the loan first.
- Taxes and penalties: None if you meet the terms of the loan. If you dont repay the loan, youll be charged taxes and penalties.
- Costs: Youll miss out on possible account growth during your loan repayment period.
Caution is key, Poorman says: A 401 loan is just thata loanso youll be required to make monthly payments. That will reduce your monthly income, so make sure it doesnt put you in a worse situation for the immediate future, he says.
Learn how to make the most of your budget .
Each month you have income that you can divvy up however you wantretirement, vacations, dinners out, and more. Its all about tradeoffs, Poorman says.
Your money is a tool for you to balance those tradeoffs and achieve your goals. Fundamentalsa budget that aligns with your income and expensescan help. And you may have debt repayment choices that help ease some of the pressure, Poorman says, including consolidation or negotiating with a creditor to figure out a reasonable repayment schedule.
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How Much Can I Borrow From My 401
The maximum anyone can borrow is $50,000. Even if you have a $1 million in your account, $50,000 is the most you can borrow under federal guidelines. If you have less than $100,000 in your account, you only can borrow as much as half your balance so if you have $84,000 in your account, you can borrow no more than $42,000. Some plans offer an option that allows you to borrow as much as $10,000 even if your account has less than $20,000 vested. Again, you need to read your plans rules or talk to your employer or plan administrator to learn more.
To Borrow Or Withdraw
When it comes to cashing out your 401, there are generally two main ways to access funds: borrowing or withdrawing. Either way, the first step is to check with your plan administrator to learn about your options.
Then, compare them. Borrowing from your 401 requires repayment within a set payback period , while withdrawing means taking money out of your 401or cashing it out altogetherwith no intention of paying it back.
You might believe that borrowing or withdrawing from your 401 is a fast way to solve your debt problem. But keep in mind that there could be significant costs involved. In particular, youll want to be prepared for withdrawal penalties.
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Not Without Paying A Penalty If You Are Younger Than 59
Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
If you are over age 59½, you are free to use your 401 to pay for anything you like. If you are younger, you can still withdraw funds from your 401 to pay off college loans, but the IRS charges a 10% penalty tax on the amount of your withdrawal, in addition to any income tax that may be due.
However, you can borrow from your 401 instead of taking out a student loan, and there are a few ways you may be able to use retirement savings to pay for college expenses.
Also Check: How Do I Take Out My 401k
Consider A Personal Loan
Sometimes, whats most overwhelming about your debt is the sheer number of outstanding accounts, each with different payment terms. With a personal loan, you can consolidate your various higher-interest debts into one monthly payment with a fixed interest rate and its often less than you were paying on the original debt. The money you save can then be used to further build your savings.
Consolidating your debts with a personal loan gives you afinite payment schedule and a light at the end of the tunnel: youll be able to see that your debt will be paid off, and when. Personal loans come with a variety of repayment schedules, so you can choose the amount you can comfortably pay each month and still allocate some funds to savings.
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Q: Does It Make Sense To Borrow From My 401 If I Need Cash
When cash is tight, your 401 can seem like a perfectly reasonable way to make life a little easier. The money is there and its yoursso why not tap it to pay off debt or get out of some other financial jam? Or you might be tempted to use it to pay for that dream vacation you deserve to take.
Stop right there. The cash in your 401 may be calling youbut so is your financial future. The real question here: Will taking the money today jeopardize your financial security tomorrow?
Im not saying a 401 loan is always a bad idea. Sometimes, it may be your best option for handling a current cash need or an emergency. Interest rates are generally low and paperwork is minimal. But a 401 loan is just thata loan. And it needs to be paid back with interest. Yes, youre paying the interest to yourself, but you still have to come up with the money. Whats worse is that you pay yourself back with after-tax dollars that will be taxed again when you eventually withdraw the moneythats double taxation!
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Bankrate follows a strict editorial policy, so you can trust that were putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.
Our investing reporters and editors focus on the points consumers care about most how to get started, the best brokers, types of investment accounts, how to choose investments and more so you can feel confident when investing your money.
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The investment information provided in this table is for informational and general educational purposes only and should not be construed as investment or financial advice. Bankrate does not offer advisory or brokerage services, nor does it provide individualized recommendations or personalized investment advice. Investment decisions should be based on an evaluation of your own personal financial situation, needs, risk tolerance and investment objectives. Investing involves risk including the potential loss of principal.
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Better Alternatives To Cds
Any suggestions on where I can stash my cash in this scary economy? CDs are paying pitifully low rates, but at least they are FDIC-insured.âGail Bjork, Hobe Sound, Fla.
With the average one-year CD paying just 0.39%, there are better places to keep your money without tying up your funds. That way, youll be able to switch to a higher-yielding alternative when rates eventually rise.
SallieMae Bank has a money market account yielding 1.10%. It has no minimum-balance requirement, no monthly fees and offers check-writing privileges â although you are limited to six withdrawals per month. Discover Bank is paying 1.10% on its no-fee, FDIC-insured savings account, which requires a $500 minimum deposit.
Some checking accounts are paying as much as 4.09% on balances up to $10,000 if you meet the qualifications, which include receiving your account statement electronically and making ten to 12 debit card purchases a month , plus one automatic payment or direct deposit per month. Look for high-yield checking accounts at www.checkingfinder.com.
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Why Using 401 To Pay Off Debt Is A Bad Idea
Any money taken out of your 401 misses out on both market gains and compound interest, and it can delay your retirement. Depending on how long it takes to repay the loan, you risk losing tens of thousands of dollars in growth over the loan term. Hence, this could mean that you have to wait longer to attain your retirement goals. This impact tends to be greater with age, and participants nearing retirement age take the biggest hit since it can be difficult to get the growth back and retire on time.
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Why He Doesn’t Recommend You Do An Early Withdrawal
Looking back, Nitzsche says that liquidating his 401 to pay off credit card debtis something he wouldn’t do again.
“It is so detrimental to your long-term financial health and your retirement,” he says.
Many experts agree that tapping into your retirement savings early can have long-term effects. It can put you at risk later on in life when you are older, not working and would otherwise need to rely on those funds.
There are also short-term effects from making an early withdrawal from your 401 as well: It doesn’t come free. Doing so has costly consequences, including both a penalty fee and taxes. For borrowers 59½ years old and younger, there is generally an early withdrawal penalty of 10%, plus taxes, which can be anywhere from 20% to 25% depending on your income and tax bracket.
If you are someone who is cash-strapped during this time of uncertainty, tapping into your retirement savings is an option of last resort. “That really should not have been touched and not something we would usually advise somebody to do,” Nitzsche says.
Personal Loans Vs Borrowing From Your 401
Home » Resources » Personal Loan Guides » Personal Loans vs. Borrowing from Your 401
Each option to obtain funds for unplanned expenses has its own pros and cons that are worth considering. We are going to explain the benefits and limitations of two common ways people get funds to pay off debt: borrowing from their 401 or taking out a short-term personal loan.
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What You Should Do Instead To Pay Off Your Credit Card Debt
In hindsight, Nitzsche says he would have handled his credit card debt differently, such as reaching out to the specific issuers to inquire about a financial hardship plan or participating in a debt management plan through a credit counselor.
He also recommends using balance transfer credit cards, which allow qualifying cardholders to move their credit card balances from one card to the next.
If you have credit card debt, this could be a good option as long as you have a plan to pay off the transferred balance within the card’s introductory no-interest period , otherwise you accrue more interest on top of that debt.
The Citi Simplicity® Card offers 0% intro APR for 21 months for balance transfers from date of first transfer . To qualify for these longer interest-free periods, you will most likely need to have good or excellent credit, but there are options available for fair credit as well.
The Aspire Platinum Mastercard® is one where applicants with fair or good credit may qualify, but the balance transfer period is shorter at only six months. After the intro period, there’s a relatively low variable APR of 9.65% to 18.00%.
Note that depending on your credit, you may not get approved for a credit limit high enough to cover the full balance of your debt. And while there are some balance transfer cards with no fee, most usually require a 2% to 5% fee .
Why Focusing On Retirement Generally Works
Retirement plans and emergency savings are both critical pieces of your overall financial puzzle, and retirement should be a major priority, as a rule of thumb. Dollars invested early on can have an exponential impact on retirement earnings, Lynch said, due to compound returns and market gains over time.
Calculate how much your current and any additional savings could be worth by retirement age with the U.S. Department of Labors Lifetime Income Calculator.
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Is There A Limit On 401 Loans
Plans can set their own limits for how much participants can borrow, but the IRS establishes a maximum allowable amount. If your plan permits loans, you can typically borrow $10,000 or 50% of your vested account balance, whichever is greater, but not more than $50,000.
For example, if you have $150,000 vested in your 401 account, then you wouldnt be able to borrow the full 50%, or $75,000, of your vested balance. The most you could borrow in that scenario would be $50,000.
On the other hand, if 50% of your vested account balance amounts to less than $10,000, your plan may include an exception and allow you borrow up to $10,000.
You may be able to take more than one loan from your 401, but the total amount of your loan balance cant exceed these limits.
