Is withdrawing from 401k a better option?

 

Whether withdrawing from 401k is a better option or not can only be ascertained after getting an insight into the process of cashing out the proceeds of a 401k account. The 401(k) plans are designed in such a way so as to encourage the employees to save for their financial needs after retirement. To achieve this objective, the law allows the investors to contribute funds on a pre-tax basis and provides it the potential to grow, tax-deferred, in the plan account until they are withdrawn by the account owner. In case a person really needs the money invested in a 401k account before retirement, he can consider withdrawing it from his plan account, as long as he clears certain specific restrictions. However, withdrawing money from a retirement account should ideally be considered a last resort option because apart from the taxes and the penalty levied on premature withdrawals, a greater financial loss results from the decades of tax-deferred compounding that the capital amount could have earned had the account owner chosen to initiate a 401k rollover instead of a withdrawal.

The three most common ways to access the funds invested in a 401k account are hardship withdrawals, non-hardship withdrawals and loans:

Hardship Withdrawals – A person owning a 401k account can have access to the invested funds under some hardship conditions. However, qualifying for the hardship provision is not easy. If the hardship withdrawal is made before the age of 59 ½, a 10% penalty has to be paid on the amount withdrawn. The amount is also taxed as regular income. Both the penalty and the taxes make it costly to perform a hardship withdrawal. After taking a hardship withdrawal, the account owner may be suspended from making contributions to the plan for at least six months.

Non-Hardship Withdrawals – These withdrawals are allowed only in some select plans. These allow the account holder to redistribute the account funds as per his requirements. Most of the account holders use this way to rollover into an IRA. This opens up a range of investment avenues before the account holder. Rollovers that are made directly to the owner of the 401k accounts have to be reinvested in a qualified plan within 60 days to avoid paying a 10% penalty.

Loans – The 401k account owners can also get themselves a loan. A loan from a
401k account allows the owner to borrow against his savings. Some such schemes use restrictions similar to those for hardship withdrawals. The loan taken against a 401k account must be paid back within a span of five years and loans cannot be rolled over into an IRA. However, if the account holder leaves a company and still has an outstanding 401k loan, he is often required to pay it back in a short time ranging from one to two months.

In an emergency, a person may be required to use the funds saved in a 401k account. However, the tax consequences and the impact on future retirement savings can be serious and therefore the help of a financial planner should be availed of, before taking any such decision.