Your 401(k) plan is meant to provide you with a retirement nest egg. Any money you take out of your 401(k) prematurely won't be available for you in retirement. You'd also be denying yourself the opportunity for that money to grow in the years until you retire. If you do withdraw some of your 401(k), you'll usually face taxes and penalties. Unless your withdrawal is for a financial emergency, you might not even have permission to access it.
Unlike an individual retirement account, a 401(k) plan is a retirement plan sponsored by an employer. Since your employer operates and maintains your 401(k), your access to your money is restricted more than with an IRA. With the exceptions of death, disability, reaching age 59 1/2, the dissolution of the plan or your severance from employment, you can only take a 401(k) withdrawal if you have a demonstrated financial hardship.
For IRS purposes, to qualify for a hardship distribution from a 401(k) you must have an immediate and heavy financial need. You can only withdraw enough money to satisfy that need, and the withdrawal must come from your elective contributions only, not any earnings or company contributions. IRS examples of heavy financial need include distributions for medical care, the purchase, care or protection from foreclosure of a primary residence, funeral expenses or the payment of tuition or educational expenses. While the IRS delineates cases in which a financial hardship distribution may be taken, employers are not required to provide such withdrawals.
Taxes & Penalties
Even if your distribution qualifies as a hardship, you'll still have to face the taxes and penalties associated with any 401(k) distribution. Since your 401(k) is funded with pre-tax money, anything you take out of it is taxable as ordinary income. If you take your withdrawal before you reach age 59 1/2, regardless of the reason, you'll owe the IRS a 10 percent early distribution penalty. You may also owe taxes and additional early withdrawal penalties to your individual state. Distributions after age 59 1/2 are still taxable but aren't subject to any early withdrawal penalties.
Taking a loan from a 401(k) can be a way for you to get money out of your 401(k0 without paying taxes or penalties. While employers are not required to provide employee loans, the IRS permits them and many employers do offer them. Under IRS rules, you can borrow up to the lesser of $50,000 or 50 percent of the amount of your 401(k). As long as you set up a payment plan and return all the money within five years, you won't have to pay taxes or penalties on any of it. You can even get an exception to the five-year repayment period if the money is used to buy your principal residence. However, if you lose or leave your job before you repay the loan, it immediately becomes due. Any amount you can't repay will face taxes and penalties as if it were a distribution.
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