HIGHLIGHTS
- Congress permits two types of hardship distributions.
- File a Form 5329 to report the tax on early distributions.
- Your plan administrator will send you a Form 1099-R.
BILL'S ANSWER
Frequently, borrowing against your 401(k) is a powerful way to lower the effective rate that you are paying on unsecured debt. I will discuss more about 401(k) withdrawal rules in just a moment.
If the interest rate on your credit card debt is higher than the interest rate on your 401(k) loan (which is almost always the situation), then a 401(k) loan will likely be a good solution for you. The benefits are less money going to cover interest fees and possibly a lower monthly payment. Ideally, you would use the extra cash flow to pay down the total debt amount faster, getting debt free in a shorter amount of time. Be sure not to "run up" your credit cards once they are paid off!
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You will want to be careful not to cash out your 401(k) savings (called "receiving a distribution" by the IRS), however, and simply borrow against your savings. If you liquidate, or sell assets from, a 401(k) before eligible retirement drawdown begins — you may face very steep tax liabilities.
If you would like more information, see the Bills.com resource Tax and penalties for 401(k) early withdrawal.
I hope this information helps you Find. Learn & Save.
Best,
Bill
Jarrod L.
Saco, ME | November 14, 2011
Saco, ME | November 14, 2011
I recently borrowed money ($10k) from my father for closing costs on a new home construction I am building. My father in turn borrowed the money from his retirement fund at a 60 no penalty if returned. I currently have $14k in my 401k. And my company retirement package has no exit strategy. Do you know of any way that I can get the money out anyway to pay back my father or transfer my 401k from my account to his? Any service you know of that may help would be greatly appreciated. Thank you very much!
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Bills.com
November 14, 2011
November 14, 2011
I do not understand your statement, "And my company retirement package has no exit strategy." This is almost certainly not true. When Congress wrote the 401(k) guidelines, it wrote at least three methods for a retired person or an employee ending employment to move their funds elsewhere, including rollover into a IRA, rollover into a new 401(k), and taking a distribution. See the IRS document 401(k) Resource Guide - Plan Participants - General Distribution Rules to learn more about how to take a distribution from your own 401(k).
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Kelly C.
Cary, NC | November 05, 2011
Cary, NC | November 05, 2011
My spouse has lost his job. Future job opportunities are there but look bleak. If we were to cash out his 401k of about 180 thousand, we could possibly refinance the loan on our house on my salary alone and prevent foreclosure. Is that a wise thing to do?
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Bills.com
November 06, 2011
November 06, 2011
Before you consider taking a withdrawal from the 401k account, please read the information about 401k early withdrawal rules.
Assuming that you are not currently eligible to make an early withdrawal, preventing a foreclosure would qualify you for that withdrawal, while refinancing would not. In any case, making an early withdrawal to prevent a foreclosure, would entail a 10% penalty and be subject to income tax. This would most likely make the refinance an uneconomical choice. Before you make any decisions contact your 401k plan administrator and a professional tax advisor.
Assuming that you are not currently eligible to make an early withdrawal, preventing a foreclosure would qualify you for that withdrawal, while refinancing would not. In any case, making an early withdrawal to prevent a foreclosure, would entail a 10% penalty and be subject to income tax. This would most likely make the refinance an uneconomical choice. Before you make any decisions contact your 401k plan administrator and a professional tax advisor.
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Louis R.
Deer Park, IL | October 21, 2011
Deer Park, IL | October 21, 2011
I see a 10% early withdrawal penalty on my traditional 401k. My company matches 25% on all contributions. Can I give myself a 12.5% raise by contributing and then early withdrawing every year if I need the money?
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Bills.com
October 21, 2011
October 21, 2011
Your 401(k) administrator may have a limit on the number of distributions an employee can receive from the plan. Also, you will be paying income tax at your customary rate on your distribution, so your net will be less than you suggest.
From a policy or philosophy standpoint, I strongly disagree with your idea of using your 401(k) as a piggybank. Your employer is being very generous by matching contributions. You should take advantage of your good fortune and maximize the percentage you contribute to your 401(k) — at minimum, make your contribution 4%, and more if you can afford it. No one knows what the future holds, and if Social Security will even exist when most of us retire.
From a policy or philosophy standpoint, I strongly disagree with your idea of using your 401(k) as a piggybank. Your employer is being very generous by matching contributions. You should take advantage of your good fortune and maximize the percentage you contribute to your 401(k) — at minimum, make your contribution 4%, and more if you can afford it. No one knows what the future holds, and if Social Security will even exist when most of us retire.
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Ray H.
Marion, OH | October 19, 2011
Marion, OH | October 19, 2011
I have heard that it is possible to roll over a 401 in to a self directed IRA. At that point form a company (John Doe's property management) and then list your home as an asset of the company. At that point pay the mortgage off with funds from the IRA..........and the home becomes an investment of the company you formed..........IS THIS TRUE
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Bills.com
October 19, 2011
October 19, 2011
Interesting idea. I would not want to be the first taxpayer to present this plan to a tax court, however. If you decide to pursue this, consult with a tax lawyer who has set up this type of plan with clients before, and has already litigated it with the IRS. If you pursue this on your own, make sure you consult with a tax lawyer or corporations lawyer to set up the corporation according to your state's laws.
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Mrs C.
Middletown, OH | October 10, 2011
Middletown, OH | October 10, 2011
I took out a 401K loan and received my check a couple days later which I used to purchase a car for my son. A couple days after that my Plan Administrator contacts me and states that they changed our 401K rules and does not allow for more than 1 loan out at a time even after I completed all the paperwork and it was approved.
It was reported as a "Withdrawal" and now the IRS is coming back to me to pay the penalties. I agree that I received the money, but only on the terms that it was a loan. What can I do?
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Bills.com
October 10, 2011
October 10, 2011
Consult with a lawyer with tax experience to learn if you have any recourse in the situation you described. My guess, note that word choice, is you have a cause of action against the plan administrator for changing the terms of the loan after you signed the contract.
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Mrs C.
Middletown, OH | October 11, 2011
Middletown, OH | October 11, 2011
Thank you for your response. Our Plan Administrator indicated that the plan was changed prior to my loan and there was a mistake on their part in allowing it. I would not have taken the money out had I known it would be treated like a withdrawal since the penalties and interest are going to cost me a fortune. I also did not receive a 1099.
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Bills.com
October 11, 2011
October 11, 2011
This reinforces my opinion that you should seek legal counsel. The IRS will compel you to pay taxes and penalties, because the money you received meets its definition of a distribution. Your claim is against the plan administrator for the harm you suffered (or will suffer) because you acted in reliance on its promise you could borrow from your 401(k), which later was shown incorrect.
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Diane .
Westminster, CO | April 26, 2011
Westminster, CO | April 26, 2011
I currently have 3 more years left on a 401K loan I took out when we purchased our home in 2000. My husband is in construction and lost his job. He has another job, but it's much lower paying than his previous one. Is there a way that I can convert the 401K loan to a dispursement, pay the tax penalties, but no longer have the monthly payment on the loan so we can survive month to month? I do get a bonus from work every March that would probably cover the tax penalty. Thanks!
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Bills.com
April 26, 2011
April 26, 2011
An unpaid loan from a 401(k) becomes a distribution. See the IRS document 401(k) Resource Guide - Plan Participants - General Distribution Rules for more details.
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David D.
Machesney Park, IL | June 17, 2011
Machesney Park, IL | June 17, 2011
I am 42 and currently on Illinois unemployment since Jan 1, 2011, due to permanent layoff. Have an opportunity to purchase a $100,000.00 home from a family member for $40,000.00, thereby decreasing monthly output for bills, etc.. I have a retirement fund for $22,000.00 that I was considering using as down-payment to reduce mortgage costs. Could hardship possibly exclude me from initial taxes? Also, would now be the ideal time to withdraw early (tax-wise) due to being on unemployment?
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Bills.com
June 17, 2011
June 17, 2011
You are always required to pay taxes on a retirement disbursement. One question is whether you would be subject to a 10% penalty or not. Check with your retirement plan administrator, to see if your withdrawal would have a penalty or not. If you meet the plan's definition of a first-time home buyer, you may not have to pay the penalty.
You are correct in stating that taking money out of the fund when you are at a low income level is better than when you are earning good money, as your tax bracket will be lower.
You are correct in stating that taking money out of the fund when you are at a low income level is better than when you are earning good money, as your tax bracket will be lower.
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Alice C.
Centennial, CO | April 21, 2011
Centennial, CO | April 21, 2011
My name is Diana, and this question is actually for my friend Alice she lost her husband in
December and she says he had $50,000 in his 401k and that all they sent her was $40.00 she doesn't understand it because she says she never signed any papers to withdraw any monies..When she showed me the paper it said 403k or 406k and I've never heard of such a thing. I know my husband withdrew from him
401K a while back , and I had to sign in order for him to withdraw any money..Alice says she didn't sign anything and yet she doesn't know what happened to the $50,000. She wants to know who she can talk to, to find out what happened.
Thank you, Diana
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Bills.com
April 21, 2011
April 21, 2011
The decedent's spouse should call the 401(k) administrator and ask the questions posed here. If the administrator's answers are nonsense, then the decedent's spouse should call a lawyer who has experience in probate law. As an aside, the decedent's spouse should already be in contact with a probate lawyer regarding the decedent's estate.
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Grace S.
Dallas, TX | April 18, 2011
Dallas, TX | April 18, 2011
Thanks for such a great resource. My husband turns 59 1/2 in October 2011. We would like to build an addition to a rental property we own to increase our income. He should have about 60,000 - 40,000 in a company funded retirment plan in which he is fully vested and $20,000 in a company matched 401k plan. I was wondering, could we make a withdrawal without penalty but taxes from either of the plans ( he will continue to work for the company) or do we have to move the money in both accounts? Also can we make a 59.5 years withdrawal while he is still working for the company and contributing to both accounts? We already have a loan against the 401k part of the account taht is not yet paid up.
Thank you.
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Bills.com
April 18, 2011
April 18, 2011
See the IRS document 401(k) Resource Guide - Plan Participants - General Distribution Rules and your spouse's 401(k) plan documents to learn the specifics of what distributions are allowed and when under your spouse's plan.
An employee may take a distribution under the guidelines Congress created, but the employer may have created more strict rules.
An employee may take a distribution under the guidelines Congress created, but the employer may have created more strict rules.
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