It can be very tempting to take an early 401k withdrawal. There are times when money is to tight that it is hard to know whether or not the bills will be covered. In other cases, it might be a large ticket item that is catching the attention. In either case, it is very important to make the right decision concerning the early 401k withdrawal. There might be more reasons that a person should not take it out than those that state a person should.
Options of the Early 401k Withdrawal
There is more than one option available for receiving money from the 401k early. There is the loan and there is the hardship withdrawal. The loan is given as other financial institutes might offer funds but the individual cannot contribute more into their 401k plan until the loan is paid off. The hardship withdrawal does not require repayment but leaves the individual will fewer funds for retirement.
Both of these have the same effect of giving the person additional funds at the moment but they also both have reasons why a person should not take them.
Reasons Not to Take the Early 401k Withdrawal
There are a few reasons why a person should not take an early 401k withdrawal in either of these forms. Some of these will pertain to some situations more than others but they all need to be considered.
Loss of Job: With an unstable economy, it is still possible for a person to lose their job even if they feel secure. In this event, repayment of the loan will be difficult. The regulations state that in the case that the position of employment is lost, the individual only has 60 days to repay the loan. Without an income, this is highly improbable.
Taxes: The income that goes into the 401k is not taxes and is therefore taxed when withdrawn. Individuals who are less than 59.5 years of age are also required to pay a 10% tax penalty on the amount that is taken out. For example, a person that fits into the 28% tax bracket who decides to take a $10,000 early 401k withdrawal will have to pay $2,800 in federal income taxes. If the individual is below the required age, they also have to pay $1,000. This leaves the individual with $6,200 not to mention the interest that they have lost.
Loss of Investment: The 401k should be viewed as an investment. These funds collect interest as it sits there. Obtaining funds through an early 401k withdrawal means that there are fewer funds gathering interest. This can be a dramatic drop of income when the individual actually retires.
Difficulty of Application: The 401k loan may not be difficult to apply for but not everyone wishes to have a loan. Individuals who want to plead for the hardship withdrawal must prove their difficulties. Not only that, but not all 401k plans allow for this type of application.
Calculating the Total Loss
The financial losses that one will incur in the future from the early 401k withdrawal often offer enough reasons as to why a person should not take this cut right now. These losses can really affect a person’s future especially if they are on a fixed income after they retire. Finances do not usually get easier once a person retires, but often makes life a little more difficult.
To calculatethe appropriate cost for any particular situation, the federal tax and the state tax has to be taken into account, plus the 10% extra tax if it applies. There is also the level of interest that is lost. To find these figures, the individual does not have to crunch the numbers themselves. There are online financial calculators to assist with this process.
Thinking It Over
When thinking over the decision, a person must look into their future needs as well as those that apply to their current situation. It is always better to look for other cheaper alternatives of finding funds instead of removing them from a retirement plan if at all possible.