What Are The Rules For 401 Withdrawal
Tax-deferred retirement accounts like 401s, 403s, and others were designed to encourage workers to save for retirement, so the rules arent super friendly for those who want to make a withdrawal before age 59½.
But depending on your financial situation, you may be able to request what the IRS calls a hardship distribution .
Employer retirement plans arent required to provide hardship distribution options to employees, but many do, so it may be worth checking with your HR department or plan administrator for details on what your plan allows.
According to the IRS, to qualify as a hardship, a 401 distribution must be made because of an immediate and heavy financial need, and the amount must be only what is necessary to satisfy this financial need. Expenses the IRS will automatically accept include:
Certain medical costs.
Costs related to buying a principal residence.
Tuition and related educational fees and expenses.
Payments necessary to avoid eviction or foreclosure.
Burial or funeral expenses.
Certain expenses to repair casualty losses to a principal residence .
You still may not qualify for a hardship withdrawal, however, if you have other assets you could draw on or some kind of insurance that will cover your needs. And your employer may require documentation to back up your request.
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Alternatives To Help Control Your Student Loan Debt
If youre struggling with student loan payments, dont feel paralyzed. Borrowing money from your 401 isnt the only option available to you. There are alternatives that can help you get your student loan debt under control while keeping your retirement savings intact. One option that could provide some relief to borrowers who are strapped for cash is student loan refinancing.
When you refinance your student loans youll take out a brand new loan from a private lender, who will review your credit history and other financial factors to determine how much they will lend to you and at what rate.
With a solid financial picture and credit history, you can stand to lower your interest ratemeaning you could reduce the amount of money you spend in interest over the life of the loan .
You could also lower your monthly payments by extending the length of the loan term, which would ultimately mean you spend more money in interest over the life of the loan, but could help free up some cash flow more immediately.
However, its important to remember that refinancing with a private lender means youll lose access to federal loan benefits like income-driven repayment plans, forbearance, and deferment.
Take control of your student loan debt by refinancing with SoFi. Find out what your new interest rate could be in just a few minutes.
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Evaluate All Your Options For Paying Down Debt
If youre in dire need to pay off your debts, look into other accounts like your savings or emergency fund. While money saved can help in times of need, your financial situation may be an emergency. To save on early withdrawal taxes and fees, you can borrow from savings accounts. To cover future emergency expenses, avoid draining your savings accounts entirely.
Minimizing The Risks To Your Retirement Fund
There are also other ways to minimize the risks to your retirement fund. For example, if you are in debt and cant afford the monthly payments, you may want to consider a debt management plan. This is a plan where you make one monthly payment to a credit counseling agency, which then uses the money to pay off your debts. This can help you get out of debt faster and avoid late fees and interest charges.
Additionally, if you are in danger of defaulting on your student loans specifically, you may want to consider student loan consolidation. That way, youll combine all your student loans into one loan with a lower interest rate. This can help you save money over the life of your loan and make the monthly payments more affordable. If you can, continue making contributions to your retirement fund however, even if you cant afford to do that, just leaving it alone for the duration of repaying your current loans is better than cashing it out. Youll thank yourself when you reach retirement.
Aside from these possibilities, there are a few others to think about, as well. You could take a cash advance from your credit card, borrow money from family or friends, or even sell some of your possessions. However, each of these options come with their own set of risks and should be considered carefully before moving forward. Nonetheless, theyre usually a better option than risking the savings youll need once youre no longer able to work.
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Refinance Your Student Loans With Elfi Today
If you are determined to pay off your loans quickly, student loan refinancing is a great option.
There are many benefits of student loan refinancing, including the opportunity to lower your interest rate and change your repayment term. To get an idea of how much you could save, use ELFIs student loan refinancing calculator.*
Does Withdrawing From Your 401 Affect Your Credit Score
Borrowing from your 401 can put your retirement at risk, but it wont hurt your credit score.
Unlike applying for a credit card, no lender will do a credit check if you borrow from your retirement fund. And even if you miss payments or default on your loan, this information wont be submitted to credit-reporting agencies.
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Doing The Math With A Regular Calculator
Even if Amy doesnt have access to a computer, a simple comparison can be created using a calculator. To estimate how much debt is to be paid off, shell need to create a list with 4 columns. The first column is for the beginning credit card balance. To that shell add the second column which shows the amount of interest owed for that month. She can calculate that from the amount owed multiplied by the annual interest rate being charged divided by 12.
From that total, shell subtract column three, which is the amount of the payment for the month. The result is column 4, the ending balance, which is the beginning balance for the next month.
A second table can be created for the 401k plan. The first column is for the beginning balance. To that will be added the second column and the third column . The total will be the ending balance in column 4. And, once again, the ending balance from one month will be the beginning balance of the following month.
Dont forget to include any employer matching contributions. They can make a big difference in your account growth. She can compare the results to see which would work better for her.
And if it turns out it makes more sense for her stop contributing to her 401k until her debt is paid? If she has a good understanding of how to maximize her 401k contributions, she can hopefully boost her retirement savings once she is debt free.
Reviewed May 2021
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Should You Use A 401k Loan To Pay Off Debt
Kevin is a former fintech coach and financial services professional. When not on the golf course, he can be found traveling with his wife or spending time with their eight wonderful grandchildren and two cats.
At a Glance
Carrying too much debt is a problem that can affect you in several other areas. At first glance, using funds from your 401 plan to pay off that debt may seem like a good idea, particularly if you have high-interest credit cards. Its your money. Why not use it? Thats the question well attempt to answer for you today. Here are the pros and cons of using a 401 loan to pay off debt:
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If You Really Want To Get Out Of Debt Consider Other Options
Dont go for the easy way, especially since that usually turns out to be the hardest way. Instead, change your habits. Stop borrowing money. Start using the debt snowball method. Create a spending plan and an emergency fund. Stick with it, because you can do it!
Yes, its super frustrating to have to wait to get your debts paid off, and to have to do what it takes to get there. But its also AWESOME, because taking the time to make a permanent change like that improves your life for the better in so many ways. Its worth it. And it usually ends up being faster, too.
Its only by doing the work that you can truly reap the long-term rewards that come from being debt free. Yes, it absolutely can be a struggle to get out of debt. It may not be a whole lot of consolation now, but the things that you struggle with often leave you with a lasting positive impact.
Do what it takes to get of debt by changing your behaviors. Both you and your 401k account will be better off for it in the long run.
And remember, no matter what you decide, be sure you understand what could happen. Get good advice from a pro who knows your situation and the laws.
Im Jackie Beck. My husband and I paid off over $147,000 in debt
My award-winning app, Pay Off Debt by Jackie Beck, was featured in Oprah Magazine and has helped over 54,000 people.
Learn more about how to get out of debt here.
Avoid Future Credit Card Debt
How did you end up with in the first place? That is a critical question to ask before you make a decision on how to pay it off.
Behavior changes may need to occur to ensure you wont be back in the same position a few years down the road.
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Options For Using Your 401 To Pay Off Debt
Before you make any moves, youll need to determine how much you are eligible to withdraw from your 401, and what penalties and taxes you would encounter. In most cases, you would be responsible for a 10% penalty and regular income taxes on a withdrawal from your 401 prior to age 59 ½.
If you were laid off you may be able to withdraw money penalty-free as long as certain requirements are met.
There are a few exceptions to this rule. For instance, if you were laid off you may be able to withdraw money penalty-free as long as certain requirements are met.
And depending on the exact terms of your 401 plan, you may be able to withdraw the money from your plan without penalty in certain hardship situations like to cover tuition or medical expenses.
If you already attended college and are trying to use your 401 to pay back student loans, that doesnt qualify for a hardship withdrawal . If youre not sure what the details of your plan entail, its worth contacting your HR representative or the financial firm that handles your companys 401 program.
Using money from your 401 to pay off debt can be a risky proposition. While on the bright side it would potentially allow you to eliminate your student debt, it also puts your retirement savings at risk.
When it comes to using your 401 to pay off your student loans, there are a couple of options to consider.
How Do You Take A Withdrawal Or Loan From Your Fidelity 401
If you’ve explored all the alternatives and decided that taking money from your retirement savings is the best option, you’ll need to submit a request for a 401 loan or withdrawal. If your retirement plan is with Fidelity, log in to NetBenefits®Log In Required to review your balances, available loan amounts, and withdrawal options. We can help guide you through the process online.
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Try The Debt Snowball Method
The debt snowball method is the fastest way to pay off debt because it gives you money wins that motivate you along the way. Heres what you do: List all your debts smallest to largest and attack the smallest amount with a vengeance while putting minimum payments on the rest. Once the smallest debt is gone, take that payment and apply it to the next-smallest debt. Then use that budget we mentioned to cut back on your spending and throw even more money at your debt. When that snowball starts rolling, itll give you the momentum you need to get out of debt for good!
Then Change Your Priorities For A While
If an interest rate break isnt enough, you can consider making some bigger changes. Dont worry, Im not going to tell you what to cut from your budget to wail on this debt. You know all that, and youve probably already done it. But at this point, you may want to free up even more cash, not by tapping your 401, but by scaling back your contributions to it.
The blanket advice is to save for retirement before tackling debt. This is especially true if youre offered a 401 that comes with matching dollars from your employer also known as free money. But once youre earning that match, the choice between contributing more and paying off debt mostly comes down to the debts interest rate versus your annual investment return. Also consider that by redirecting pretax retirement savings toward debt, youll lose out on that tax break.
Read More: Should I consolidate my debt?
If youre looking at a longer stretch or youve already done all of the above it might be time to look at debt relief. It will open the door to some additional resources, while preserving the retirement savings youve worked hard to build.
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Cons Of Taking Out A 401k Loan To Pay Off Debt
Ok, but what about a loan, you might ask. The answer to Should I borrow from my 401k to pay off debt? is very likely no.
There are limits on how much you can borrow, and rules for paying it back. The IRS says that Generally, if permitted by your plan, you may borrow up to 50% of your vested account balance up to a maximum of $50,000. The loan must be repaid within 5 years, unless the loan is used to buy your main home. The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan.
If you qualify under the CARES Act, you may borrow up to a maximum of $100,000, and the due date to start paying it back is delayed for one year.
But a huge con with a 401k loan is that if you lose your job or the 401k plan ends, you could be in deep doo-doo. Thats because if that happens, the 401k plan can require you to repay the entire loan in full within a limited amount of time. If you dont repay it in time, it gets treated as a distribution.
Depending on when that happens, that could be very little time. The IRS states that you have until the due date, including extensions, for filing the Federal income tax return for the taxable year in which the offset occurs.
This is the case even if you leave your job involuntarily such as if you get laid off or fired.
How Long Do You Have To Repay A 401 Loan
Generally, you have up to five years to repay a 401 loan, although the term may be longer if youre using the money to buy your principal residence. IRS guidance says that loans should be repaid in substantially equal payments that include principal and interest and that are paid at least quarterly. Your plan may also allow you to repay your loan through payroll deductions.
The CARES Act allows plan sponsors to provide qualified borrowers with up to an additional year to pay off their 401 loans.
The interest rate youll pay on the loan is typically determined by the plan administrator based on the current prime rate, but it and the repayment schedule should be similar to what you might expect to receive from a bank loan. Also, the interest isnt paid to a lender since youre borrowing your own money, the interest you pay is added to your own 401 account.
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