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Borrowing or withdrawing money from your 401(k) plan before you retire

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Borrowing or withdrawing money from your 401(k) before you retire is a big decision. After all, you’ve worked hard and saved hard to build up your retirement fund. While taking money out of your 401(k) plan is possible, it can impact your savings progress and long-term retirement goals so it’s important to carefully weigh the risks, costs and benefits. 

Most people have two options:

  • A 401(k) loan
  • A withdrawal

Whether you’re considering a loan or a withdrawal, a financial advisor can help you make an informed decision that considers the long-term impacts on your financial goals and retirement. 

Here are some common questions and concerns about borrowing or withdrawing money from your 401(k) before retirement.

A 401(k) loan   

A 401(k) loan allows you to borrow against your own 401(k) retirement account, or essentially borrow money from yourself. While you’ll pay interest similar to a more traditional loan, the interest payments go back into your account so you’ll be paying interest to yourself.  

People borrow from their 401(k) for a variety of reasons, such as funding the purchase of a house  or paying for a dependent’s college tuition. While there are some plans that only allow participants to take a loan for certain approved reasons, in most cases, you won’t need to declare why you are borrowing from your 401(k).  

Common 401(k) loan questions

Can I borrow against my 401(k)? 
Check with your plan administrator to find out if 401(k) loans are allowed under your employer’s plan rules. Keep in mind that even though you’re borrowing your own retirement money, there are certain rules you must follow to avoid penalties and taxes. 

How much can I borrow against my 401(k)? 
You can borrow up to 50% of the vested value of your account, up to a maximum of $50,000 for individuals with $100,000 or more vested.  If your account balance is less than $10,000, you will only be allowed to borrow up to $10,000.

How often can I borrow from my 401(k)?  
Most employer 401(k) plans will only allow one loan at a time, and you must repay that loan before you can take out another one. Even if your 401(k) plan does allow multiple loans, the maximum loan allowances, noted above, still apply. 

What are the rules for repaying my 401(k) loan? 
In order to be compliant with the 401(k) loan repayment rules, you’ll need to make regularly scheduled payments that include both principal and interest, and you must repay the loan within five years. If you’re using your 401(k) loan to buy a primary residence for yourself, you may be able to extend the repayment period. 

What if I lose my job before I finish repaying the loan? 
If you leave or are terminated from your job before you’ve finished repaying the loan, you typically have 60 days to repay the outstanding loan amount.   

What happens if I don’t comply with the 401(k) loan repayment rules? 
Failure to follow the 401(k) loan repayment rules may result in tax penalties in addition to a 10% early withdrawal penalty.  

Summary of loan allowances

If you have this much vested in your 401(k): Standard rules allow you to borrow up to this much:
$100,000 or more $50,000
$10,000 to $100,000 50% of your vested value
$10,000 or less $10,000

 


Pros and cons of 401(k) loans

Advantages of a 401(k) loan Disadvantages of a 401(k) loan 
Getting a 401(k) loan is generally a quick, easy process Money removed from your 401(k) will not be able to grow and will not benefit from the effects of compound interest 
If you follow the 401(k) loan repayment rules, you won’t be subject to taxes or penalties on the loan amount If you don’t follow the 401(k) loan repayment rules, you may be subject to taxes and penalties
You don’t need a credit check for a 401(k) loan, and your credit won’t take a hit if you default If you lose (or leave) your job while the loan is outstanding, you typically will have to repay your 401(k) loan within 60 days
Interest paid on the loan is not lost to a lender, because you are the lender You must replace the money you borrowed from your 401(k) with post-tax dollars
There are no early repayment penalties if you pay off the loan early You can’t deduct loan interest payments for tax purposes

 

Withdrawals from a 401(k)  

401(k) hardship withdrawals 
If you find yourself facing dire financial concerns and need cash urgently, your 401(k) plan may offer a hardship withdrawal option. Unlike a 401(k) loan, you won’t have to repay the money you take out, but you will owe taxes and potentially a premature distribution penalty on the amount that you withdraw. In addition, IRS 401(k) hardship withdrawal rules  state that you may not take out more money than what is needed to cover your hardship situation. 

In order to qualify for a 401(k) hardship withdrawal, your plan administrator must offer this option (not all of them do) and you must be facing an “immediate and heavy financial need.” Approved 401(k) hardship withdrawal reasons include:

Postsecondary tuition for you or your family

Medical or funeral expenses for you or your family

Certain costs related to buying, or repairing damage to, your primary residence

Preventing your immediate eviction from or foreclosure of your primary residence

If you experience a financial hardship from a circumstance not on this list, you may still be able to qualify for a hardship withdrawal, so check with your plan administrator.

In-service, non-hardship withdrawals 

This type of withdrawal is only allowed under certain plans and is mainly used by those who would like to explore other investment options. Learn more about in-service distributions. An Ameriprise financial advisor can provide more detailed information on in-service 401(k) distributions.

Pros and cons of withdrawing money from your 401(k)

Pros Cons
You’ll get access to cash quickly You’ll be taxed on the amount that you take out
  If you’re under 59.5 years of age, you’ll be subject to a 10% 401(k) withdrawal penalty
  It may affect your long-term retirement savings goals

 

Withdrawing vs cashing out your 401(k)
Withdrawing money from your 401(k) is not the same thing as cashing out. You can do a 401(k) withdrawal while you’re still employed at the company that sponsors your 401(k), but you can only cash out your 401(k)  from previous employers. Learn what do with your 401(k) after changing jobs.
 

401(k) loan or withdrawal - is it a good idea for me?  

Taking money out of your 401(k) plan is a big decision that can impact your savings progress and long-term retirement goals. If you’re contemplating this option, consider connecting with an Ameriprise advisor. They’ll work with you to carefully weigh the risks, costs and benefits.

Rollover evaluator

If you have multiple retirement savings accounts held in more than one place, the rollover evaluator will help educate you to understand the pros and cons of keeping your retirement savings in an employer-sponsored plan such as a 401(k) or 403(b) versus rolling it over into an IRA.

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At Ameriprise, the financial advice we give each of our clients is personalized, based on your goals and no one else's. 

If you know someone who could benefit from a conversation, please refer me.

Background and qualification information is available at FINRA's BrokerCheck website.

Do not use this information as the sole basis for investment decisions; it is not intended as advice designed to meet the particular needs of an individual investor.
Be sure you understand the potential benefits and risks of a 401(k) loan or withdrawal before implementing. As with any decision that has tax implications, you should consult with your tax adviser prior to implementing an IRA rollover.
Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
Ameriprise Financial Services, LLC. Member FINRA and SIPC.