Withdrawal from the 401 (k) plans- Advantages and the disadvantages of the same

401 (k) is a plan which can be used as retirement saving or withdrawal at the time of hardships. But one needs to understand the effect of withdrawing or saving money and the consequences of it on tax.

Whenever an individual needs cash they go for the retirement savings as it is the easiest option available. One should avoid using the cash for short term as the main purpose is to save the money for future needs and goals. If one gets in the habit to take money from this 401 (k), one may end up losing the entire amount till retirement. Also depending on the frequency of taking out money, one may end up getting additional tax. 401 (k) can be an option when one is completely out of resources.

Plan loans

It is important to read the document properly to understand whether one is allowed to borrow money or withdraw money from a 401 (K).  There are some employers which only allow money withdrawal in the case of financial hardship where as there are some cases when one is allowed to borrow money for buying a home, car, etc.

Typically, getting a 401 (k) loan is simple. There isn’t a stack of papers to sign or credit check to go through. The fees are negligible, which at most may include a small processing fee, and that’s about it.

401 (k) loan is easy to get and one doesn’t need to go through much in order to get it. There are no useless stacks of papers or credit check. Also the fees charged are least possible.

Limit of borrowing

One cannot borrow the entire amount in 401 (k) loan. One has the limit of $50,000 or one-half the amount assigned in the plan, whichever is lower. Therefore one should understand the terms and conditions and then go for it.

Repayment of loan

Generally speaking, like any other loan, you will have to repay the personal installment loans you’ve borrowed from your 401 (k) within five years. This will include payments at least quarterly to satisfy the two parts that make up the loan which are principal and interest. There are certain exceptions, for instance, if you borrowed the funds to purchase your home, you may obtain an extension on the repayment of the loan.

One will have to pay back the borrowed money within five years, in general sense. In order to make a payment one will have to make the payments in two parts, principal and interest.

One should understand the requirement of repayment of the loans. If an individual does not read the requirement properly and is unable to follow the instructions, the money which is loaned is considered taxable and ordinary income taxes and a 10 % early withdrawal penalties are considered.

Advantages

  • If an individual stick to the instructions, there are no penalties or taxes.
  • The interest rates, under 401 (k), are similar to any other bank or institutional for the loan.
  • An individual pays the interest to oneself only, as the money borrowed is credited to the retirement plan of the individual.

Disadvantages

  • When an individual is unable to pay back the loaning amount at the given time, the loan is treated as a taxable distribution.
  • If an individual quits the job or is fired and he has outstanding debt in the 401 (k) plan, he is required to pay back the money within 60 days or else it will be treated as a taxable distribution or he may even be asked to pay a penalty of 10%.
  • The interest on the loan is not tax free
  • With after tax dollars, loans are paid back.

Hardship withdrawals

When an individual has no other way to pay back the money and is going through a financial difficulty, then 401 (k) has the provision to allow for withdrawal.

Some employers lay down certain provisions for hardship withdrawals, such as:

• To pay Medical expenses

• To pay funeral expenses

• To bear educational fees

• To bear the costs of home renovation etc.

Disadvantages of withdrawing money from 401 (k) in cases of hardship:

• It will reduce the retirement savings

• They have ordinary income taxes.

• If an individual takes hardship distribution, one can be prohibited to contribute to the 401 (k) plan.