Cashing out your 401k before retirement can be very expensive, so you may want to think twice before doing so. You should think it over very carefully before finally deciding to take money out of your 401k – especially if you’re just doing this for quick financial assistance. Some people are really tempted to cash out 401k, especially during hardships — but this can cost a lot of money today, and even more profit opportunity in the future.
There is actually another (and often better) option: to borrow money from your 401k account, which can also help with your quick financial needs. Most of the time, borrowing from 401k is much better than a total cash out. With this, it is essential to be familiar with the 401k loan rules.
Understanding the Rules for a 401k Loan
In general, an employee who needs to borrow money from their 401k account can take either half of the retirement balance, or $50,000 – whichever is lesser. The borrower needs to agree to start paying back the loan on his next payday. The payment is automatically deducted from the borrower’s salary most of the time.
The term of the loan will actually depend on the purpose of the loan. For example, if the account holder borrows money from his 401k account in order to buy a residential property, the loan term shall be five years or less. Of course, the borrower will still need to pay a reasonable rate of interest for the amount that he borrowed.
The good news is that borrowers pay back the loan, including the interest, to themselves, and not the financial institution. This is because the amount of every loan repayment is directly housed in the account holder’s 401k plan in general. As a matter of fact, since borrowing against 401k is not a loan in its truest sense, related fees are normally minimal.
Understanding the 401k Hardship Withdrawal Rules
It is necessary for the account holders of 401k to understand and get themselves familiar with the rules of the 401k hardship withdrawal if they plan to borrow money from their retirement funds. Just like the Individual Retirement Account where the account holders are allowed to take money out of IRA in certain circumstances, so as with the 401k. With the 401 hardship withdrawal, the 401k account holders are allowed to withdraw 401k early as long as they are undergoing certain suffering that needs investment funds from the 401k retirement account to cover their needs and expenses.
It is important for the account holders to make sure that they are undergoing an approved financial hardship, as they will not be allowed to make early distribution if their circumstances do not qualify. Some of the most common qualified circumstances or financial difficulties that may allow early distribution from 401k accounts are funeral expenses, medical expenses, buying first residential property, enrollment for college expenses for an immediate family member, or payment for a loan to prevent foreclosure. Usually, a Proof of Need is necessary to serve as an evidence to a financial difficulty.
How Do You Prove Your 401k Hardship Withdrawal?
Your specific 401k plan administrator can specify what exact documentation they require for the proof of financial need for a hardship withdrawal. For example, if the money is used to prevent your home from a foreclosure, they may require documentation from your mortgage company that the home is about to enter foreclosure.
Taking money out of your 401k should only be done as a last resort. Thoroughly review all your other options for accessing money before you start tapping into your 401k retirement savings.