What is a 401(k) Loan or Hardship Withdrawal? What do you want to know

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Sometimes life throws a difficult, unexpected (and expensive) event at you and you wonder how you’re going to pay for it. Hopefully, you can rely on the money you’ve set aside in an emergency fund to pay for your expenses, but if you don’t have enough (or none at all), you might be looking for a alternative solution.

If you have a 401(k) account through your employer, you may have the option of taking out a 401(k) hardship loan or using a 401(k) hardship withdrawal to help fund some of your these expenses.

However, it’s important to note that before turning to a 401(k) loan, you must first exhaust all of your other options for additional cash. That means exploring any emergency money you might have set aside, tapping into any extra savings you have, or even seeing if it’s possible to take a side hustle that will cover the cost of what you need to pay. Indeed, when you borrow from your retirement account, you remove the possibility that this money will continue to grow over time, especially if you withdraw your entire balance.

Here’s what else you need to know about taking out a 401(k) loan or 401(k) hardship withdrawal.

How 401(k) Loans Work

A 401(k) loan lets you borrow money from your occupational retirement account on the condition that you repay the amount borrowed with interest. The good news is that payment amounts and interest accrue directly to your account.

The interest rate you pay on a 401(k) loan can change over time. According to Debt.org, the interest rate you would pay on a 401(k) loan is usually a point or two higher than the loan rate used by banks. The rate used by banks is called the prime rate and it is influenced by the federal funds rate, so it can change over time. So, if the prime rate is 5.2%, the interest rate you pay on your 401(k) loan may be around 6.2% to 7.2%.

Because your 401(k) is an employer-sponsored account, you will need to follow your employer’s plan rules regarding taking out a 401(k) loan. Many employers have limits on how much of your balance you are allowed to borrow and how many loans you can borrow from your account per year. You’ll need to check your employer’s plan guidelines before taking the next steps to borrow. of your 401(k).

Keep in mind that if you were to quit your job before repaying a 401(k) loan in full, you may need to repay the money you borrowed immediately (or at least over a much longer period of time). short).

What about 401(k) hardship withdrawals?

401(k) loans should not be confused with 401(k) hardship withdrawals. A hardship withdrawal is not a loan and does not require you to repay the amount you have withdrawn from your account. You will pay income tax on a hardship withdrawal and possibly a 10% early withdrawal charge if you withdraw before age 59.5. However, the 10% penalty can be waived if you can provide proof that the money is being used for a qualified hardship, such as medical bills or if you have a permanent disability.

Another key difference between the two is that with 401(k) hardship withdrawals, you would not be able to pay yourself back what you withdrew from your account. This is not the case with 401(k) loans.

Qualifications for a 401(k) hardship withdrawal depend on your plan and the plan administrator’s rules, so be sure to check how you can qualify.

Financing alternatives

Overall, you should only take out a loan on your 401(k) if you’ve exhausted all other financing options, because withdrawing money from your 401(k) means you’re preventing it from growing over time. You will lose the power of compound interest when you withdraw money from your retirement account.

If you need money to cover a costly and unforeseen event that is stressing you out, the first thing you should look at is your emergency fund. That’s the purpose of your emergency fund, after all. It’s generally recommended that you keep your emergency fund in a high-yield savings account, such as Ally Bank’s or Goldman Sachs’ Marcus, as these typically earn more interest than a savings account. traditional savings.

If you don’t have an emergency fund, you might consider turning to other non-retirement savings that you have set aside.

Ally Bank Online Savings Account

Ally Bank is a member of the FDIC.

  • Annual Percentage Yield (APY)

  • The minimum balance

  • Monthly fee

    No monthly maintenance fees

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *Cycle withdrawal limit of 6/instructions is waived during the Coronavirus outbreak under Regulation D

  • Excessive transaction fees

  • Overdraft fees

  • Offer a current account?

  • Offer an ATM card?

    Yes, if you have an Ally current account

Marcus by Goldman Sachs High Yield Online Savings

Goldman Sachs Bank USA is a member of the FDIC.

  • Annual Percentage Yield (APY)

  • The minimum balance

    None to open; $1 to earn interest

  • Monthly fee

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *Cycle withdrawal limit of 6/instructions is waived during the Coronavirus outbreak under Regulation D

  • Excessive transaction fees

  • Overdraft fees

  • Offer a current account?

  • Offer an ATM card?

U.S. Bank Visa® Platinum Card

On the secure site of US Bank

  • Awards

  • welcome bonus

  • Annual subscription

  • Introduction AVR

    0% for the first 20 billing cycles on balance transfers and purchases

  • Regular APR

    15.24% – 25.24% (Variable)

  • Balance Transfer Fee

    Either 3% of the amount of each transfer or $5 minimum, whichever is greater

  • Foreign transaction fees

  • Credit needed

Wells Fargo Reflect℠ Card

On the Wells Fargo secure site

  • Awards

  • welcome bonus

  • Annual subscription

  • Introduction AVR

    0% intro APR for 18 months from account opening on eligible purchases and balance transfers. Intro APR extension up to 3 months with on-time minimum payments during introductory and extension periods; balance transfers made within 120 days qualify for the introductory rate

  • Regular APR

    13.74% to 25.74% Variable APR on purchases and balance transfers

  • Balance Transfer Fee

    3% introductory fee ($5 minimum) for 120 days from account opening, then up to 5% ($5 minimum)

  • Foreign transaction fees

  • Credit needed

If the expense you’re trying to cover is a medical expense, it might be a good idea to make a withdrawal from your Health Savings Account (HSA) if you have one. HSAs are an investment account for medical expenses. You make pre-tax contributions to the account, your balance grows tax-free, and you also won’t owe tax when you make a withdrawal for eligible medical expenses. It is the triple tax advantage that emerges from this type of account and which makes it possible to avoid going into more debt to pay all or part of a medical expense.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

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