Why You Should Refrain from Withdrawing from Your 401K During a Hardship

| December 23, 2014

We all face financial hardship at some point in our lives. One very common remedy sought out by those dealing with unexpected circumstances like a personal injury, work-related injury or medical bills is to borrow against their retirement. While reaching into your retirement may be a temporary fix to your financial problems, it will also have long-term effects that will negatively impact your future, especially after retirement.

Withdrawing Funds from Your 401(k)

401(k)s are employer-sponsored retirement plans that are subject to different rules regarding borrowing against the funds. The penalties associated with borrowing against your retirement vary from employer to employer, but there will most certainly be penalties involved.

The IRS does allow for penalty-free withdrawals from your 401(k) for those in severe financial need, but ultimately they defer to the sponsoring employer on your plan. The following are considered financial hardships that warrant penalty-free withdrawals:

  • You have been diagnosed with a qualifying disability.
  • Your medical expenses are less than or equivalent to the amount that is allowable as a medical expense deduction.
  • You have court-ordered alimony or child support.
  • You have been involved in a natural or other disaster for which the IRS has agreed to grant relief.
  • If you have parted ways with your employer and have to set up equal periodic payments for five years or until you reach the age of 59 1/2.

The IRS will asses a 10 percent penalty for taking money out of your 401(k) if you do so before you reach the age of 59 1/2. However, if you are no longer with your employer, you are welcome to make withdrawals from your 401(k) penalty-free so long as you are at least 55 years of age.

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Think Long-Term

It is always crucial to remember that whatever you take out of your 401(k) will not be there for you when you retire. While early withdrawal can help fix temporary financial troubles, you may be severely hindering your retirement goals in the long run by withdrawing early. Moreover, pulling money out of your 401(k) will increase your taxable income for the year, meaning you may end up owing more money to the IRS on top of the money you owe for early withdrawal.

If you are in financial trouble, contemplating bankruptcy filing or have questions about your 401(k), contact Morgan & Morgan today. Here at Morgan & Morgan law firm, we specialize in assisting clients with their finances. Contact us today for a free consultation.

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