A 401(k) is a tax-advantaged retirement plan that you might be lucky enough to access through your workplace.
If you sign up for a 401(k) at your workplace, you will agree to make regular contributions to the plan. These contributions will be made from paycheck deductions. Your employer may also increase your savings by offering matching contributions, boosting what you put away by the end of the year. All of these contributions will grow with the help of various investments that your workplace’s plan offers —these are typically mutual funds and ETFs (exchange-traded funds).
Over the years of working at this company, your 401(k) plan will accumulate more and more savings. By the time you retire, you should have a considerable nest egg on your hands.
That sounds absolutely perfect, doesn’t it? So, what’s the catch? Well, one thing that you should know about 401(k)s is that you shouldn’t withdraw from this savings plan before you retire.
The savings in your 401(k) are specifically meant to be used in your retirement years. This is why withdrawals made before you are 59 ½ years old are considered “early withdrawals.” There are some exceptions to this general rule, but not many. For instance, if the 401(k) owner becomes permanently disabled, they can access their savings before they reach the minimum of 59 ½ years old. You can read the list of IRS’s 401(k) withdrawal exceptions.
Early 401(k) Withdrawals
So, what happens if you make an early withdrawal, and you don’t qualify for any exceptions? You will face a 10% early withdrawal penalty from the IRS. So, if you are planning to withdraw $10,000 from your account, you will end up owing $1,000 for this penalty alone.
Your distribution will also be considered taxable income by the IRS. So, when you have to file your tax return for the year, you might find that you owe a lot more than you originally anticipated.
These consequences are set up to discourage savers from making unnecessary withdrawals before they get to their retirement years.
What If It’s an Emergency?
When an emergency expense falls into your lap, you might be tempted to withdraw from your 401(k) to pay it off. If the emergency expense isn’t enormous (for example, a $1000 plumber’s bill), you should refrain from doing this. Not only will you face an early withdrawal penalty and taxes, but you will also be diminishing your financial cushion for the future.
So, if your emergency expense is on the smaller side, consider a different solution than your retirement savings. You could look into an online loan as a solution. One of the biggest benefits of online cash loans is that they tend to have fast application processes. It could take you less than 10 minutes to fill out your loan application. This will be a huge relief when you’re trying to resolve an emergency.
You can avoid borrowing funds through a credit card or online loan altogether by setting up an emergency fund. An emergency fund is a collection of savings reserved for urgent, unplanned expenses. Withdrawing from this savings account should help you tackle your emergency expense without facing a major penalty.
It’s important to know about the problems of early 401(k)withdrawals. Now, you might not make the mistake of accessing your retirement funds far too soon.