A 401(k) plan is an employer-sponsored retirement savings plan, wherein deductions from an employee’s paycheck serve as contributions. These accounts are a key vehicle to tax-deferred savings and accumulation of a nest egg when you’re anticipating retirement, but they can also be a source of frustration in the meantime.
During our working lives, there may be instances where we might need an early withdrawal from a 401(k) to cover current expenses. If you are not yet of retirement age, 59 ½, all the financial research and knowledge says making a withdrawal from your 401(k) is ill-advised. The math does not work out in the long term, and you can sacrifice massive upside over years of compounding returns. However, the statistics do not look at your situation, personally. There are some instances where withdrawing from your 401(k) could make sense relative to other options, so ensure you are reviewing your individual situation and alternatives, such as personal loans, renting vs. buying, and other before delving into your 401(k) funds. If it really does make sense, understanding the options for accessibility is essential.
Each 401(k) plan is different, and you can review the details of the plan by requesting a summary plan description (SPD), which is a required “plain English” version of the plan description. An important detail from the SPD will be if your current employer allows withdrawals while employed. If so, to make a withdrawal, you would: send documentation to the plan sponsor (usually via HR), pay a processing fee, and then receive a net amount from your account. Early 401(k) withdrawals are taxed as ordinary income, carry a 10% penalty fee, and might be adjusted if your account is not fully vested.
If you are currently navigating whether or not to make a withdrawal, it is important to know that there are options that may benefit you in the long run and save you additional penalties. Before taking an early withdrawal for your 401(k), find out if your plan allows loans or has a hardship withdrawal provision. The availability of these selections depends upon the rules of your employer.
Next time, we’ll discuss some specific situations such as hardship withdrawals, loans, or leaving a job.
Sources: Yahoo Finance, Reuters.com, and JP Morgan Market Insights
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