One of the top rules of retirement planning hasn’t changed – taking money out of a qualified retirement savings account before your retirement could be a costly mistake. Withdrawals such as hardship distributions, could affect the funds available to you when you are set to retire. Experts warn that a 401(k) hardship withdrawal should be your absolute last resort after you have used or explored all other options.
Your 401(k) plan may offer alternatives to hardship distributions
First, check out your 401(k) plan document. If allowed, there could be several options such as a loan or an early in-service withdrawal that may be able to help you out. Federal guidelines say you can borrow up to 50% of the vested portion of your 401(k) account. You will pay interest as you’re paying the loan off, but it is credited back into your account. As long as you pay the loan back it isn’t taxable. In addition, you can still contribute to the 401k plan and pay back the loan at the same time, although it would be wiser to put that additional money toward the principal to get it paid off in a shorter time – saving on interest charges.
Early distribution may be another option, but you must first meet certain criteria, including age. For an in-service distribution you need to be at least 59-1/2 years old. If you are, you will not have to pay the 10% federal penalty. However, your distribution will be fully taxable at your current tax rate.
When you have exhausted all of the distributions options your 401(k) plan allows, you still may be able to tap into your 401(k) account for money if you experience what the IRS defines as an “immediate and heavy financial need.” It is a federal requirement that you utilize loan or in-service distribution options before you can resort to a hardship withdrawal.
What are the consequences of taking a hardship distribution?
Whether you are a Millennial or Baby Boomer, a hardship withdrawal could have a significant impact on your retirement outcome. As a Baby Boomer, your years of “catching up” will be shorter. In some cases, you may never entirely catch up to where you once were prior to the withdrawal. It could also mean you may need to postpone your retirement until you are financially more stable, dramatically setting you back on your retirement goals.
As a Millennial, things aren’t quite as bleak. While a hardship disbursement will certainly set you back, you will have many more years in the workplace to make up the difference. However, they are still costly in the short term when you pay taxes and those participants that are not 59 ½ or older may be subject to a 10% penalty tax.
By taking money out now you are moving further away from your retirement goals. A federal tax penalty of 10% may be applied to your withdrawal in addition to your regular tax if your hardship doesn’t meet predetermined guidelines. In addition, you will be unable to contribute to the plan for the next six months and you will miss out on the compounding interest over the life of the account, again setting you back on your retirement goals.
Here’s the bottom line, the decision to take a hardship distribution is truly a personal one and is often surrounded by extenuating circumstances. Loan or age related withdrawal options need to be exhausted. It should be your absolute last resort for withdrawing funds from your 401(k) retirement fund.
Flexible 401(k) plans like those offered by CoPilot retirement savings service can offer you and your employees options that not only help to meet retirement goals but can help see you through the rough spots on your path to get there. CoPilot is changing retirement outcomes by changing the conversation. Contact us online or give us a call at 800.236.7400.
Nicholas Crary, CPFA - Financial Services Representative - email@example.com - 800-236-7400 x3381
Nick is a subject matter expert on 401(k), retirement savings, participant advice, small business 401(k), investments, education on options.