A 401(k) is a tax-deferred retirement account. If your short-term cash needs outweigh your desire to build a retirement nest egg, you may feel tempted to raid your retirement account, but strict rules exist that limit your access to your 401(k) money. In some instances, you can make withdrawals, but doing so may cause your tax bill to rise.
You can't generally access cash held in your current employer's 401(k) plan, but you can make withdrawals from accounts held with former employers. You have to pay a 10-percent federal tax penalty on 401(k) withdrawals made before you reach the age of 59 1/2. You also have to pay ordinary state and federal income tax on 401(k) distributions. The Internal Revenue Service waives the 10-percent penalty, but not the taxes, if you become disabled or if you're over the age of 55 and just lost your job. Other penalty waivers include withdrawals made due to court orders and withdrawals made by account beneficiaries.
You can make a withdrawal from your current employer's 401(k) if your plan includes a provision for hardship withdrawals. Your employer has the option of including such a provision in your plan. You qualify to make a hardship withdrawal if you need cash to pay for tuition, to prevent eviction or foreclosure, or to cover non-reimbursed medical costs. You can also make a hardship withdrawal if you need cash to make a down payment on a principal residence, or if you need money to cover funeral expenses.
Some 401(k) plans include a loan provision. Where available, you can borrow the lesser of $50,000, or 50 percent of your vested balance. Vested funds are the sums of money in the account that actually belong to you. Under federal rules, it can take up to six years for your employer's matching contributions to become vested, while your own contributions are yours from day one. A 401(k) loan term can last for up to five years. Your principal and interest payments are deposited back into your own 401(k) account. If you fail to repay the loan, you have to pay taxes and possibly the 10-percent tax penalty on the remainder of the loan balance.
Some companies allow you to make in-service 401(k) withdrawals if you want to roll some of your money into an individual retirement account or similar plan. People over the age of 59 1/2 can roll over all of their vested cash. If you're below that age, you can roll over your own contributions as well as your earnings. You can also roll over any money you previously rolled into the 401(k) from a retirement account held elsewhere.
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