401K's and Penalties for Taking Some Funds Out

We recently did this to buy a 2nd home. We have quite a bit in there, so it didn't make too much of a dent . . . . BUT it was expensive. We took out 20,000 and paid the federal taxes up front out of the account, so it ended up costing us 28,000. Then tax time came around and we got dinged big time! We usually get about 5,000 back, but only got 1,000 back due to the 10% penalty.

don't do it. huge tax fees. if you have a Roth you can take out the money you put in directly without any tax penalities but not the interest or earned money.

My company administers retirement plans. Your friends were eligible for what is called a primary-residence loan. They have to pay back the loan, with interest, to the account from which the money was borrowed. The loan interest is usually indexed to the prime rate (sometimes plus or minus a point or two, depending on the plan set up) or to the return of a conservative investment in the plan. There are two types of 401(k) loan - General Purpose and Primary Residence. GP loans have to be paid back in 5 year, PR in 10. If a borrower separates service (becomes terminated by quitting, retiring, getting fired or laid off etc.) there is a small window of time to re-pay the loan (usually 90 days) in full. If the borrower cannot pay the loan, the outstanding balance is treated as a withdrawal and is taxed and penalized accordingly. For both types of loans, the amount available to borrow is the lesser of 50% of your vested account balance or $50K. Your plan should have a website where you can log in, see how much is available to borrow, and how much your loan payments would be. If you don't have a website, you can call your plan's customer service number and a representative can model the loan options for you.

Withdrawals are much worse and it makes absolutely no sense to take a withdrawal for paying off regular debt. First, it can be hard to qualify for a WD - assets left in an old plan, like with a former employer, are available for withdrawal. After-tax contributions and sometimes employer contributions such as profit sharing or match money may also be available. Other than that, you usually have to prove financial hardship (as in medical emergency or losing your house) to gain access to your money. Regardless of which money is available for WD, you will have to pay a 10% early withdrawal penalty AND have 20% withheld for estimated income taxes. The WD will count as income on your taxes for this year. If your tax bracket is under 20% you will get a little of that back at tax time and if it's over 20%, you'll owe even more at tax time.

All in all, the statistics for those who remove money from their 401(k) plan via loans or withdrawals are not good - of course there is selection bias in that those who need to access their money are usually lower earners, explaining the financial problems that led them to need the money, but even when compared to those with similar salaries, ages, and years in the work force, those who borrow or withdraw from their retirement funds rarely catch up to their peers and rarely have account balances that indicate retirement readiness. You really have to preserve your nest egg as much as possible. Don't casually consider tapping your retirement funds if you have other ways to pay down your debt. Also, studies show that people who borrow a lump sum to pay down debt (either from retirement or home equity) are MUCH MORE LIKELY to be back in the same situation in a few years vs. those who painfully chip away at their debt payment after payment, month after month, year after year. If debt is a problem consider a program like Suze Orman or Dave Ramsey to systematically get yourself out of debt. You can get books by both authors at your local library.

You really have to look at the rules for your plan. But, in general, a loan is always better than a withdrawal but you generally only have access to a portion of your vested amount. In my plan, you can take a loan for up to 50% of your vested amount.

I have strategically used a loan from time to time...especially when I could see the money would be doing more good for another purpose.

I took a withdrawal once when I changed jobs and I would never do that again. I lost nearly 40% to taxes and penalties.

Keep in mind also, with a loan, you have to repay immediately if the job is lost (under every plan I've ever had anyway).

HUGE MISTAKE!

Unless you are about to become HOMELESS do NOT touch your 401K!

I skimmed through most of the responses, and wanted to add one thing. First, a loan is what your friends did, they have to pay it back, and all interest they are paying should actually be going back into their account (that was the rule a few years ago anyway). The big thing, if you leave your job, willingly or not, you will have to pay back the money immediately, or pay all of the taxes everyone else mentioned. Talk to your 401k company to see all their rules. I wouldn't take a loan out of my 401k. I actually no longer have one, I moved mine to an IRA when I started working for myself, but I am able to take out money I put into my Roth IRA with no penalties (since I already paid taxes on it before), but I wouldn't do it unless it was an absolute emergency and I was going to lose my home. There are a lot of ways to get out of debt (I helped my husband get out from $10,000 before we got married), spending less is normally the best way to go.

Borrowing from your 401K depends on how it is setup and that you do pay back. Actually taking money out is a high tax penalty. For some plans you have to show hardship, plus you have money deducted from it and you have to claim it on your taxes. If you MUST take the funds, I would say borrow it. It is kind of like taking a loan from yourself and you do pay an interest rate--maybe 4.25% or so. BUT remember you are lowering the value of your account and the possible return you would have if it stayed in there. They say borrowing or taking out is the worst to do but sometimes, borrowing makes sense. I took a loan from mine to pay a huge medical bill last year. I have a long way to go to retirement.

The only way I am aware of to take funds without huge penalty is to stop a foreclosure but not sure with that.

I am not saying taking a loan is a great thing but if you absolutley need the money, then it may be the route to go. There are a lot of things to consider first.

There are HUGE penalties for early withdrawal from a 401K. Better to suspend contributions and use that extra to pay down your debt.
Rule of thumb: Never touch those funds except EXTREME emergency. (And paying off debt is not an extreme emergency.)

It's best that you speak with the benefits rep at your job about this. I think you are not taxed if you pay it back in full within a certain timeframe. Also, paying down debt does not exclude you from penalties. From what I remember (when I used to work) if you borrow from your 401k to save your home you are not penalized. But that was so many years ago so..... talk to your benefits rep. That way, you're very clear on all penalties before you borrow the money.

Yep!! There are penalities AND taxes.....you need to talk with your financial advisor - the one who holds the 401K and see how much you want to take out and what the penalities will be....and if you have to pay it back.

Updated

Yep!! There are penalities AND taxes.....you need to talk with your financial advisor - the one who holds the 401K and see how much you want to take out and what the penalities will be....and if you have to pay it back.

Are you talking about a withdrawal or a loan?

If you take a withdrawal, it must be for a specificed approved purpose. In other words you can't just take it out because you want some extra money. Approved reasons fall under a "hardship" and include things like extreme medical bills, to prevent foreclosure, purchasing a house, and college educational expense. When you withdraw the money, you will need to pay a 10% penalty. In addition, to the penalty, this is income so you'll be paying income tax on the amount you withdraw.

Some companies will allow you take a loan from your 401K. Basically, your loaning yourself money. I'm not up to date on the rules for a loan.

In general, taking money out of a 401K is not a good idea. You really should consider all other options first.

I used to work in the 401(k) department of a large financial firm and some of your answers are actually half true because there is some confusion on terms. My shortest possible answer: "Taking" money out which so many people say is "the biggest mistake" is one thing, BORROWING money from it is a totally different thing, and depending on your situation, can absolutely make sense. There's no black and white answer to this, because there are too many factors (age, date of expected retirement, vesting date, income, employment situation, savings situation and other accounts you may have, interest you'd pay yourself vs interest you are currently paying, individual plan-specific rules, etc, etc).
I would not suggest "taking" money out because yeah, there are penalties charged by the firm if taken before retirement age AND you will be taxed on it as additional income, plus state taxes if you are charged that where you live, as well as just not having an account to build your retirement or the "free money" that your company is putting in, and money that is not in your account is not making money for you. There is such thing as "hardship withdrawals" but each plan has its own rules on that, and I would seriously not suggest that for you. To tell the truth, most plans would not accept debt payment as a hardship so you wouldn't be able to take it out without actually closing your account which would be a big mistake.
For borrowing money, under certain circumstances, it can really make sense. Yeah, you'll miss out on whatever money you'd be making if the market is doing well. If the market is stagnant, you could also miss out on losing some of that money too if you think about it. If you were to take a loan from the bank, you will pay interest to them and it will be on your credit report. This isn't always helpful (in my PERSONAL experience: we both had "blah" credit when we first got married, were working very hard to pay off all debt from our past lives, rebuild our credit reports, and save money for a house because we were in a 1 bedroom apartment with an 18 month old boy. We didn't want to pay as much or more in monthly payments for a 2 bedroom apartment as we'd pay for a house in a great neighborhood. We got all credit debt paid off, improved our credit a bit, saw that if we could come up with a certain amount down, we could get a loan from the bank for $200 more per month for a 3 bed/2 bath house with amazing energy efficiency - read lower utility bills - in a great school district and an amazing neighborhood than we were paying for the 1 bedroom apartment with NO energy efficiency. The bank was charging a substantial amount more for a loan than our 401(k) would, which in that amount of money is quite a chunk of change. We knew that as we paid off debts, we would also need to get a car -brakes were iffy and the ac was out in Tx heat, so we didn't want our credit showing another loan that would lower our standing, etc). For OUR situation, it just made sense to us to borrow the down payment from ourselves. Then instead of making monthly payments to a bank, we were paying OURSELVES back, which was easier for me to stomach than paying some bank. Instead of paying interest to the bank, we were paying ourselves a lower, doable interest rate. We took our money out at a decent time when stuff still had some value so we didn't lose too many shares by selling out at a time when the value was uncomfortably low. We could see things were going to get a little worse (they did) for the market, so it actually helped us to take some money out before the value went down, and we were paying ourselves back and helping that balance until the market improved (which it has, for many). We were responsible; I urge anyone who is going to borrow money from anything to be responsible! Yes we got the house, and 2 newer (not new, but newer) vehicles, but we are totally debt free except a modest, totally doable mortgage on the house now. We have paid our 401(k) loan back at a lower interest rate, and that helped us, it saved us money in the long run. This was years ago when we first started out, so I can't remember the exact numbers offhand, but it was something like 4.25% from 401(k) vs 8% from a bank and I know our credit cards used to be 14.99% which is ridiculous. I'd rather pay 4% than 15%! Then be diligent to pay it off quickly, which is easier to do when the interest rate is THAT much lower. It really depends on your situation. You can talk to a financial professional, call for an agent who handles your personal 401(k) plan and they will be able to look at the plan and discuss the ins and outs with you as they pertain to your specific plan. Take notes on your discussion, and use those notes to compare what would happen if you tried a couple banks OR the interest of just paying the debts with no loans. See what makes the most sense for you by looking at all 3 options on paper. You can make your decision then, based on having the facts in front of you.
As for the tax issues that people seem to be so concerned about: how about finding a high interest bank account and designating it just for taxes? Example: one bank I use has a pitiful savings account of 0.21% but the checking account is currently 4.01%, with the stipulation that we use the card 15 times every month to earn that interest. Well, we put the money that we designate to pay our taxes into that account every quarter into that account. We do use the card but it is for purchases UP TO $10 each (like running to the store quickly for milk, or if I am getting a prescription with a $10 copay, that kind of thing). It is liquid, it is making money, and it is separate because frankly we won't be using that money because we're saving it for specific needs, and we won't NEED the money but once a year (A. of every year). We make 4.01% interest on the property taxes instead of overpaying and letting the government make that money instead, or scrambling to cough up some money suddenly when it's due. This is also where the rent checks from a property we own go, to make some decent interest and be separate from living expenses so we have it on hand if something needed to be prepared or whatever. Ramsey does have good tools to help you make a budget that you can live with that includes putting aside money for things like paying your loan back, or setting aside taxes, or whatever. This will only work if all involved (husband AND wife) can be responsible though. Together, we check our numbers with the online bank statement twice a month on Sundays to make sure we're still on track, not to get onto each other but because we're a team and it takes teamwork to have it all run smoothly. I do not like these cut and dry answers where they give you a "YES" or "NO" and don't know anything about your personal situation, or even the plan rules. But you MUST be responsible and not get yourselves into trouble again. This is not an easy fix. We took our loan out to assist us with a home, at the beginning of our marriage, and we were both gainfully employed. We are not in debt anymore (except the modest mortgage), and I stress that this is important. There are no easy fixes.

In addition to what others have said, one of the reasons not to borrow money from your 401k is because you will be paying taxes twice. The money you are currently putting in your 401k is pretax dollars and when you eventually retire and start taking money out that is when you'll be taxed on it. The problem with taking a loan out from your 401k is that you'll be paying it back with after tax dollars. So the money you put back into your 401k you've already paid taxes on, but then when it comes time to retire and start taking the money out - you'll be taxed again. Double taxation! Not a good idea.

We took a loan against my 401k to pay down debt. I've been at my job a long time, it's very secure. The interest rates on the cards were outrageous, we were paying a ton in interest each month. With those two factors it made more sense to take the 401k loan then to keep paying the min + $100 a month on the cards. We make a monthly payment (actually each pay period it auto-drafts from my check) with interest, but it's far less than what we were paying on the credit cards. The additional money we save is being put in a savings account so that we can repay the loan earlier. I would only do it if you are 110% convinced you will no longer use the cards, otherwise you will end up in a worse situation than you are already in.

Taking a loan out of your 401k is a really stupid idea. It is called paying stupid tax because that is what you will be paying. Look at it this way, it would be like taking out a loan at the bank at 40% interest to pay down your debt. Would you do that? If not, then don't take out a 401k loan. Get a second job to pay down debt.

We were in a position a few years ago where we had to do this. There are some instances where it is allowed without early withdrawal penalties (to prevent foreclosure, in the event of huge medical bills, and a few others, but you have to talk to your plan administrator to find out for sure). The penalty from the plan administrator is around 10% of the money you want to withdraw. So if you want to take $10,000 out, you will pay a $1,000 penalty. In addition to this, it will be taxed by the IRS as income (because, of course, you paid into the plan pre-tax). You will be taxed at your usual tax rate - but keep in mind that the money may put you into the next tax bracket up. (But if you have offsetting deductions and a good tax guy, it could work out.) Also, the plan administrator does not withhold taxes from the amount they send you - so let's say you are in the 28% tax bracket - you owe $2800 of that $10,000 you're borrowing in taxes, so plan for that. So out of $10,000 you withdrew, your net is $6200.

All this being said, I would weigh whether you are paying high interest on the debt you're looking to pay off. If you are, like a lot of people, paying 30%+ on your debt, then yes, it might be worth it. BUT, please be sure you have some kind of plan for putting money back into your retirement.

I do think it is rather nonsensical that we have been preached to forever that we have to put money into our 401K's pre-tax, never to touch it, etc etc. (Let's face it, this is entirely a product of Wall Street, and in no way are you guaranteed to actually have money to retire on just because you put money into a 401k - note that investment regulation has not improved at all since the recent debacles on Wall Street that got us into this mess we're in.) There are some instances where it does make sense financially to take money out. You just need to be sure you're going into it with your eyes wide open, knowledge of what you're going to owe in taxes, and to have a plan together for putting money aside for retirement. We decided to cash out of the 401k system, and instead buy rental properties outright. It's not for everyone, but we are making a lot more on our money both short- and long-term than we were in stocks and bonds.

Double wammy if you take a withdrawal - taxed at an enormous rate by the governament AND penalized by the plan administrator. A loan may be differant. Call the plan administrator to find out your options and the consequences. Then talk to a tax advisor about the tax penalty.

Check with your plan manager but usually if you have any after-tax contributions in the plan you can take a withdrawal of those funds without being taxed. If the withdrawal includes any taxable earnings you will pay a 20% penalty tax on those earnings only.

Taking a loan from your account would mean you have to pay it back through payroll deductions. The money is not taxable unless you are no longer employed by the company and then you are responsible for paying it back or paying the 20% penalty tax plus any additional income tax.

Most of the time you are not eligible to take a withdrawal from the pre-tax portion of the account without being at least 59 1/2 years of age or proving a hardship if you are currently active in the 401k.

If you have a 401k with a former employer then you can take the money out but will have to pay the 20% penalty tax plus any additional income tax.

Good luck,
K.

It will be taxed, it will be considered a loan, it will have interest rate, it will be considered income and you will have to pay it back to yourself. It will have penalties attached to it if you leave the company before repaying it, so if you really absolutely can do without taking from it, then don't.

It depends on your company, nut typically you can take a loan against your 401K and pay it back with a very low intersp rate over a period of time. Since it is a loan and you are paying it abck there are no penalties. But again, it depends on how your company has it set up. If you take a financial hardship withdrawl then you have to pay penalties. Best to take a loan and pay it abck with interest. In trun you are just paying yourself back and get the interest.

10% penalty at time of withdrawal and you are taxed on the amount as income according to your total financial situation. I took some money out last year, and because my income is so low, the taxes were low. If my income would be higher, I would taxed on that money as income at the appropriate rate. In the past I have taken a loan out against a 401k. Your financial advisor can help you understand how that works.

Depends on how much you take out, but the penalties can be huge. I would talk to your tax person and see what they recommend. They are after all the one that will give you the bad news on penalties.

Ok, just so you know any money you take out counts as income and will very likely bump you up a bracket or 2 when you pay taxes next year... so save the needed amount to pay those taxes! Since this can actually take your tax rate from 15% of your income to 40% (also is it worth it if the rest of your income is being taxed that much more, you M. actually be taking home less if you take out the money!), you need to make sure you REALLY need that money NOW because to pay off debt to then owe uncle sam is a bummer! Now also remember you will have the amount you take out taxed 10% ON TOP OF the increase in your tax rate. This can be avoided if you pay it all back within before Jan 1.

I had vangard for yrs and at first I would take out little loans here and there and pay them back and it wasn't a problem. Fast forward a few years and when I tried again I was told unless it was a absolute necessity I couldn't withdrawl any! Wth! Its my money! You just need to check with and make sure they go ober the penalties!

I don't see that anyone has mentioned the specific numbers, so here goes:

If you withdraw the money from your 401k (not a loan) and you are under 59 1/2, you will pay a 10% Federal early withdrawal penalty and a 10% state early withdrawal penalty, so that's 20% you lose right off the top. Then you have to pay your regular Federal and state income tax, which you should be able to find from your 2010 income tax returns. Federal tax rates range from 10% to 35%, although you appear to be a NV resident, and NV doesn't have an income tax, but I believe the NV early penalty would still apply.

Call your 401-k administrator and discuss all the tax and other issues with them. The other moms that posted brought up the major points you need to consider. In addition to the federal/IRS rules that all plans must follow, each plan differs a little as to other specifics, so you must talk to them to get the facts for your plan. BTW -- I agree with many of the other moms, taking a loan or a withdrawal should be your last option, and only for an extreme emergency.