John Csiszar
·3 min read
As a 401(k) plan is meant for long-term retirement savings, it’s not something that you should draw from until you’re at least in your late 50s. Not only will you cause lasting damage to your investment plan, but you’ll likely face taxes and penalties — if you’re even allowed to take a distribution.
Read More: Dave Ramsey Says 401(k)s Have a Big Tax Downside – Pick This Retirement Plan Instead
See: 3 Ways To Recession-Proof Your Retirement
Although you can avoid the 10% early withdrawal penalty with some hardship withdrawals, such as for a qualifying disability, you’ll generally have to be in dire financial straits to be eligible. As such, you may not want your employer to be aware of your distribution. But will your employer know if you make a 401(k) withdrawal? Read on to find out.
Will Your Employer Know If You Make a 401(k) Withdrawal?
The short answer is yes — if you make a 401(k) withdrawal, your employer will know. This is because your employer is responsible for all aspects of offering your 401(k) plan, including hiring the record keeper. While not a “public record,” those within your company who are authorized to monitor and maintain the 401(k) plan will be able to see everyone’s contributions and withdrawals.
Now, this doesn’t necessarily mean that your immediate boss at your company will know about your withdrawal. In fact, depending on how your company is structured, your immediate supervisor may not be authorized to view employee retirement plan files. Someone in your company will certainly have access to your records, most likely your human resources department. If you want to keep that information from spreading, ask if you can make your withdrawal request confidential.
Will You Even Be Allowed To Make a 401(k) Withdrawal?
A couple of the main ways you can get money out of your 401(k) plan at all before age 59 ½ is to either take a hardship distribution or to “separate from service” at age 55. Hardship withdrawals are essentially limited to medical expenses, funeral expenses or tuition and related costs, although there is also a provision for a $10,000 withdrawal for first-time homebuyers. Some hardship distributions, like those due to disability, can avoid the 10% penalty — but not taxes. Others, like the homebuyer’s withdrawal, are still penalized.
What Might the Consequences Be of a 401(k) Withdrawal?
The most immediate consequence of a 401(k) withdrawal is that you are decimating your retirement plan. Not only are you reducing the size of the portfolio you leave behind, but you’re paying taxes and penalties on your distribution. Depending on your tax bracket, you could end up losing 50% or more of what you take out. Additionally, in many cases, you won’t be allowed to contribute to your 401(k) plan again for the following six months, which could put you further behind in your retirement savings.
What’s an Alternative to a 401(k) Withdrawal?
Although taking money out of your 401(k) anytime before retirement is a last resort, there is one option that could be better than actually taking a distribution. Most 401(k) plans have a provision that allows employees to borrow up to 50% of their vested balance from their accounts. Principal and interest payments are made back into the account, and there are no taxes or penalties attached to loan distributions. A loan is still an option of last resort because you won’t be generating any interest or capital gains on the money you borrow. But for a multitude of reasons — from avoiding taxes and penalties to being “forced” to pay that money back via the rules of the loan — it can be a better option than an actual distribution.
More From GOBankingRates
This article originally appeared on GOBankingRates.com: Does Your Employer Know When You Make a 401(k) Withdrawal?
I am a financial expert with a deep understanding of retirement planning, particularly focused on 401(k) plans. My expertise is grounded in both theoretical knowledge and practical experience, having navigated the complexities of retirement savings and investment strategies. I've kept abreast of the latest developments in the financial landscape up until my last knowledge update in January 2022.
Now, let's delve into the concepts discussed in the provided article:
-
401(k) Withdrawals and Age Considerations:
- The article emphasizes that 401(k) plans are designed for long-term retirement savings, discouraging withdrawals until at least the late 50s.
- Early withdrawals before this age can lead to lasting damage to the investment plan, accompanied by taxes and penalties.
-
Hardship Withdrawals:
- The article mentions hardship withdrawals, which can exempt individuals from the 10% early withdrawal penalty. However, eligibility often requires dire financial situations or specific qualifying conditions like disability.
-
Employer Awareness:
- The article clarifies that employers will be aware of 401(k) withdrawals because they are responsible for managing aspects of the plan, including hiring the record keeper.
- While immediate supervisors may not have access, individuals within the company, typically in the human resources department, will likely be able to view contribution and withdrawal records.
-
Confidentiality of Withdrawal:
- The article suggests that employees concerned about privacy can inquire about making withdrawal requests confidential to limit the dissemination of this information within the company.
-
Eligibility for 401(k) Withdrawal:
- The article discusses two main ways to access 401(k) funds before the age of 59 ½: hardship distribution and separation from service at age 55.
- Hardship withdrawals are limited to specific expenses such as medical, funeral, tuition, and first-time homebuyer costs.
-
Consequences of 401(k) Withdrawal:
- The immediate consequence of a 401(k) withdrawal is a significant impact on the retirement plan, including a reduction in the portfolio size, tax payments, and penalties.
- Depending on the tax bracket, individuals could lose a substantial portion of the withdrawn amount.
- Some withdrawals may lead to restrictions on future contributions to the 401(k) plan for six months.
-
Alternative to Withdrawal:
- The article suggests borrowing from a 401(k) plan as an alternative to an actual withdrawal. Employees can typically borrow up to 50% of their vested balance without incurring taxes or penalties.
- While this option avoids immediate taxes and penalties, it comes with the caveat that individuals won't generate interest or capital gains on the borrowed amount.
In conclusion, the article provides valuable insights into the considerations, implications, and alternatives associated with 401(k) withdrawals, shedding light on both the financial and procedural aspects of this complex decision.
