Taking a 401k loan or withdrawal | What you should know | Fidelity (2024)

FAQs

Is it better to take a withdrawal or loan from 401k? ›

Borrowing from your 401(k) isn't ideal, but it does have some advantages, especially when compared to an early withdrawal. Avoid taxes or penalties. A loan allows you to avoid paying the taxes and penalties that come with taking an early withdrawal.

A 401(k) loan is generally not a good idea, for those who can avoid it. However, borrowing against retirement savings may be prudent for those who need a short-term bridge loan when, for example, buying a house.

The IRS will penalize you. If you withdraw money from your 401(k) before you're 59½, the IRS usually assesses a 10% tax as an early distribution penalty. That could mean giving the government $1,000, or 10% of that $10,000 withdrawal, in addition to paying ordinary income tax on that money.

You do not have to prove hardship to take a withdrawal from your 401(k). That is, you are not required to provide your employer with documentation attesting to your hardship. You will want to keep documentation or bills proving the hardship, however.

Looking back, Nitzsche says that liquidating his 401(k) to pay off credit card debt is something he wouldn't do again. “It is so detrimental to your long-term financial health and your retirement,” he says. Many experts agree that tapping into your retirement savings early can have long-term effects.

Generally, you have to include any previously untaxed amount of the distribution in your gross income in the year in which the distribution occurs. You may also have to pay an additional 10% tax on the amount of the taxable distribution, unless you: are at least age 59 ½, or. qualify for another exception.

Generally, the employee must repay a plan loan within five years and must make payments at least quarterly. The law provides an exception to the 5-year requirement if the employee uses the loan to purchase a primary residence.

In most cases, they can easily find out if your situation is considered difficult. Some 401(k) Hardship Withdrawal plans may need to provide some form of documentation. Ask your 401(k) Hardship Withdrawal plan provider what you need as proof of difficulty.

Can a company deny 401k withdrawal? ›

A company can deny a 401k withdrawal request, especially if the funds are unvested. A 401k plan includes several requirements that must be met to access your money legally.

One of the easiest ways to lower the amount of taxes you have to pay on 401(k) withdrawals is to convert to a Roth IRA or Roth 401(k). Withdrawals from Roth accounts are not taxed.

The 4% rule is easy to follow. In the first year of retirement, you can withdraw up to 4% of your portfolio's value. If you have $1 million saved for retirement, for example, you could spend $40,000 in the first year of retirement following the 4% rule.

For that reason, many experts recommend investing 10-15 percent of your annual salary in a retirement savings vehicle like a 401(k).

Certain medical expenses. Burial or funeral costs. Costs related to purchasing a principal residence. College tuition and education fees for the next 12 months.

You're permitted to take up to $100,000 out of an individual retirement account (IRA) or employer plan such as a 401(k) or 403(b) plan if the need for the distribution is related to COVID-19. This change adds a special coronavirus rule to the hardship withdrawal rules for 401(k)s.

To be eligible for a hardship withdrawal, you must have an immediate and heavy financial need that cannot be fulfilled by any other reasonably available assets. This includes other liquid investments, savings, and other distributions you are eligible to take from your 401(k) plan.

Does Cashing Out a 401(k) Hurt Your Credit? Taking money from your 401(k), via a loan or withdrawal, doesn't affect your credit. What's more, taking money from your IRA or other retirement accounts has no bearing on your credit or credit score.

Among the pros of a 401(k) withdrawal is that you won't have to repay those funds. Taking money from your 401(k) “can make sense to use funds to pay off high-interest debt, like credit cards,” Tayne says. On the downside, your retirement savings balance will drop.

Once you start withdrawing from your 401(k) or traditional IRA, your withdrawals are taxed as ordinary income. You'll report the taxable part of your distribution directly on your Form 1040.

How does IRS know about 401k withdrawal? ›

For retirement accounts, the IRS gets its information from the Form 1099-R that employers are required to complete. The form includes the total amount of money distributed to you, as well as the amount of the distribution that you'll need to include in your taxable income.

There are no penalties.

Unlike with an early withdrawal from your 401(k), there are no penalties or taxes owed if you take out a loan against your 401(k). There is one caveat, however: You need to pay it back on time.

Will a 401k loan appear on my credit report? Answer: No. Loans from your 401k are not reported to the credit-reporting agencies, but if you are applying for a mortgage, lenders will ask you if you have such loans and they will count the loan as debt.

The interest rates on most 401(k) loans is prime rate plus 1% or 2%. The prime rate as of September 2022 is 5.5%. Since you're borrowing your own money, the interest isn't paid to a lender. Instead, the interest is paid back into your 401(k) account.

401(k)s do not charge early repayment penalties to participants who pay off the loan early. The loan statement will show the additional credits to the loan account, and the remaining 401(k) loan principal balance.

Repayment will cost you more than your original contributions. The leading purported plus of a 401(k) loan—that you're simply borrowing from yourself, for a pittance—quickly becomes questionable once you examine how you'll have to repay the money.

Also, some 401(k) plans may have even stricter guidelines than the IRS. This means that even if any employee has a qualifying hardship as defined by the IRS, if it doesn't meet their plan rules, then their hardship withdrawal request will be denied.

Early Withdrawals From a Retirement Account

You will also owe income tax on the amount withdrawn unless you qualify for an exception. Sometimes - but not always - these types of early withdrawals trigger an audit, typically a correspondence audit where the IRS sends you a letter.

You must pay income tax on any previously untaxed money you receive as a hardship distribution. You may also have to pay an additional 10% tax, unless you're age 59½ or older or qualify for another exception. You may not be able to contribute to your account for six months after you receive the hardship distribution.

In general, you can't take a distribution from your 401(k) account until one of the following events occurs: You die, become disabled, or otherwise terminate employment. Your employer terminates your 401(k) plan.

How long does employer have to process 401k withdrawal? ›

Generally, when you request a payout, it can take a few days to two weeks to get your funds from your 401(k) plan. However, depending on the employer and the amount of funds in your account, the waiting period can be longer than two weeks.

Think about it. You will be paying off the non-401k loan with after-tax income (that's once) and your earnings in your 401k (you will have the dollars invested in something since you have not borrowed them) will be tax at distribution (that's twice).

You can do a 401(k) withdrawal while you're still employed at the company that sponsors your 401(k), but you can only cash out your 401(k) from previous employers.

You can rollover your 401(k) into an IRA or a new employer's 401(k) without paying income taxes on your 401(k) money. If you have $1000 to $5000 or more when you leave your job, you can rollover over the funds into a new retirement plan without paying taxes.

In summary, the four percent rule is a popular guideline that suggests retirees can safely withdraw 4% of their retirement balance each year without fear of running out of money. This can be an effective method to start your financial planning, but it shouldn't be your only tool.

The earlier you plan for retirement, the better shape you're likely to be in. Bringing in $100,000 a year may require total investments worth close to $2 million. Social Security, pensions, and retirement accounts are not the only sources of income in retirement.

If your intention is to preserve your assets to pass them down to your children or other beneficiaries in the future, withdrawing 5% each year will ensure a secure retirement so long as your nest egg is large enough to allow it.

This is also not accounting for rising costs due to inflation, large, unexpected costs and taxes. On the other hand, if they're able to continue to live this affordably, they can estimate their $300,000 in savings will last approximately 25 years.

In most cases $300,000 is simply not enough money on which to retire early. If you retire at age 60, you will have to live on your $15,000 drawdown and nothing more. This is close to the $12,760 poverty line for an individual and translates into a monthly income of about $1,250 per month.

Can you take a loan and a withdrawal from your 401k at the same time? ›

Most 401(k) plans allow you to take a 401(k) loan against your retirement savings, or a hardship withdrawal if you are below 59 ½. However, there are circ*mstances when you can withdraw from your 401(k) if you have an unpaid loan.

Since the 401(k) loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on your debt-to-income ratio or on your credit score, two big factors that influence lenders.

401(k) Loan Rules

The maximum amount that you may take as a 401(k) loan is generally 50% of your vested account balance, or $50,000, whichever is less. If your vested account balance is $10,000, you may borrow up to $5,000.

The greatest benefit of taking a lump-sum distribution from your 401(k) plan—either at retirement or upon leaving an employer—is the ability to access all of your retirement savings at once. The money is not restricted, which means you can use it as you see fit.

Typically, you have to repay money you've borrowed from your 401(k) within five years by making regular payments of principal and interest at least quarterly, often through payroll deduction. However, if you use the funds to purchase a primary residence, you may have a much longer period of time to repay the loan.

Any money borrowed from a 401(k) account is tax-exempt, as long as you pay back the loan on time. And you're paying the interest to yourself, not to a bank. You do not have to claim a 401(k) loan on your tax return.

The 401(k) loan process can anywhere from a day if you do it online to a few weeks if done manually. Once completed, it may take two or three days for a direct deposit to reach your account.

Since the 401(k) loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on either your debt-to-income ratio or your credit score, both of which are major factors that lenders consider.