Wayne McCormick
Broker/Owner
Realty Executives of Northern Arizona
A Quick 401k Breakdown:
Your 401k is a retirement plan where your money can grow tax-free. However, to avoid any monetary penalties, you can’t withdraw your money until you’re 59 1/2. You get to choose what percentage of each paycheck you want to invest in your retirement. The money is withdrawn from your paycheck pre-tax. Therefore, you won’t owe any tax money until you start to withdraw at retirement age. Withdrawing before then can lead to an early withdrawal penalty plus additional income taxes. However, there are some exceptions.
Borrowing from Your 401K
When borrowing from your 401K you don’t have an early withdrawal fee and you don’t have to pay income taxes on the money you withdrew. Think of this strategy as a loan from yourself, to yourself. Just like a regular loan, you will need to pay yourself back, plus interest. Usually, you will need to pay back your account within about five years, but this time frame can vary.
The consequence though, is that your repayment deposits don’t count as contributions – so you don’t get a tax break. When borrowing you can usually take out half of your vested account balance or $50,000. It depends on which has less money.
Pro Tip: Just because you’re borrowing from yourself doesn’t mean you’re not taking on debt. In the eyes of a lender, you may no longer qualify for certain mortgages or rates.
Withdrawing from Your 401K
If your 401k provider doesn’t allow borrowing from your 401K or you need more than $50,000, you will have to withdraw from your account. You will incur the 10% withdrawal fee and have to pay income taxes on top of that. Unlike borrowing, you don’t have to pay this money back.
If you are under the age of 59 1/2, you are allowed one “hardship” withdrawal in certain circumstances such as buying your first home. With a hardship withdrawal, you are allowed to take out $10,000 and avoid the 10% penalty fee, but you still have to pay income taxes.
