401k Withdrawal Versus Loans

The 401k is one of the most popular retirement vehicles used by Americans these days. When times get tough, such as with the Great Recession, the need for hard, cold cash can often trump any thoughts of retirement. The question for many is whether a 401k withdrawal or loan makes more sense.

When you have to put food on the table, you have to put food on the table. It as simple as that. Discussions about the value of compounding in retirement accounts over time and the like go out the window when it feels like the sword of Damocles is hanging over your head. This is particularly true when you have kids.

You have money in your 401k. So, what path should you take to get money out of it? The first thing to understand is taking a loan is usually the better choice. The reason for this is you avoiding paying income tax and a 10 percent early withdrawal penalty on the money you pull out. The secondary positive reason is you must pay back the loan with interest. How is this a benefit? Well, think about it for a minute. Who are you paying interest to? Yes, yourself!

Are there times when doing a withdrawal makes more sense? Yes. First, some 401k plans simply don’t allow you to take loans. Second, there are circumstances where you can avoid the 10 percent penalty and even tax. They include items like paying for college tuition, a first home, certain medical expenses and payments to avoid eviction or foreclosure on your home. You should speak with a financial planner to get the specifics on each of these, but the important thing to understand is the options are available and you would not be forced to repay the 401k.

When it comes to pulling money out of a 401k before you retire, a loan is almost always the preferred choice. That being said, check with your plan administrator to see if it is even an option first.

By: Barry Milton

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Barry Milton writes about retirement planning and other financial subjects for UFCAmerica.com.