Hardship Withdrawals and Loan from 401K Retirement Plan:

The goal of retirement savings plan is to ensure maximum financial security for you in your golden days. Savings you make through your contributions towards your retirement plan ensures you financially comfortable retired life. What I mean is that retirement savings plans are basically aimed at your post retirement life. Considering this fact one must avoid withdrawals and loan from retirement plans. Having said this, I concede that one may face certain hardships where he has no other financial option left other than withdrawal or loan from retirement plan. If you are facing such situation and are thinking to opt for loan or withdrawal from 410K retirement plan you must know the pros and cons of such loans and withdrawals from 401k retirement plan. Considering the federal government has made provisions to permit plan administrators to grant loans and hardship withdrawals from 410K retirement plan.

Loans from 401K Retirement Plan:

The main benefit of acquiring a loan from 401K Plan is that the proceeds of this loan are exempted from taxes and penalty fee, barring the default cases. There are no restrictions or laid down guidelines on the use of loans acquired from 401K retirement plan. However, some plan administrators have put restrictions like number of outstanding loans and minimum balances of loan. Basically, companies do this to decrease administrative costs. Some companies/plan administrators ask the employees to obtain consent of their spouse, if they are married, before obtaining the loan.

401K Individual Loans:

Like other 401K plans 401K sole proprietor plan and 401k small business owner’s plan also offers your facility of loan to overcome your financial hardships. This provision is also applicable to owners having business that is not incorporated.

Establishing a 401k plan and contributing towards it may provide significant benefits to 401k individuals and solo proprietors of small businesses in reducing company and personal taxes. This also enables you to make more secured tax-deferred savings when compared to other methods which are in vogue traditionally.

Limits of Loan from 401K Plan

Usually, an employee is allowed to borrow maximum up-to 50% of the account balance. The upper limit is set at $50,000. If an employee has already availed loan from 401K plan during preceding one year, he can borrow 50% of his account balance to maximum $50,000. His outstanding loan will be deducted from this amount of loan. Except in the case of home purchases loan, all other loans obtained from 401K plan are to be refunded within period of succeeding five years. If you have acquired loan for home purchases, you are eligible to get longer period for repaying your loan.

No doubt, the proceeds in your 401K plan account are your money. Still you have to pay interest if you are acquiring loan from this account. Generally, plan administrators/employers decide the interest after adding one or two percent to the existing prime rate of interest. You may be paying interest on your own money but doing this you are benefited in two ways:

• Firstly the amount of interest you pay to 401K plan is tax exempted

• Secondly, whatever amount you pay as interest you are sure to get it back at the time of retirement in the disbursement form. Think if you had taken a loan from a bank and paid the interest?

Disadvantage of taking loan from 401K Plan

In fact there is no disadvantage, at least for an employee, to obtain loan from 401K plan. However, such loans may cause hindrance in dollar cost averaging process which may have adverse effect on long-term results. The other aspect of consideration is stability of employment. As per the existing rules 401K loan is to be fully repaid within 60 days after leaving the job or termination of job. If the employee fails to meet this criterion he would be declared defaulter and have to pay taxes and penalty.

401K Withdrawal

When you are ineligible for loan or your company does not provide you loan facility from 401K plan, you can still access the cash from your 401K account by means of withdrawal. You must fulfill following criterion to get withdrawal from 401K savings.

• When you are facing severe financial crunch and need immediate cash
• The amount of loan applied by you must match with the amount of the purpose for which you are seeking loan. Later should not be greater than the earlier.
• Your all other sources have exhausted and your requirement justifies the withdrawal.

• You have no other option to exercise under provisions of 401K plan, like loan, and non-taxable and distributable loans from 401K plan have been already availed by you.

If you meet the above criterion, you may acquire cash by means of 401K withdraw. There are laid down purposes for which you can exercise withdrawal.

• Purchase of a home
• For acquiring higher education. This includes expenses on boarding charges and tuition fees for one year. You can obtain withdrawal under this category for yourself or your dependants and spouse. You can also get withdrawal from 401K plan for your children even though they may not be dependent on you.
• For preventing foreclosure or eviction of your residence
• You can utilize withdrawals from 410K Plan for medical expenses, specifically those which are tax-deductible and can not be reimbursed, for yourself, dependents and spouse.

You must understand that all hardship withdrawals from 401K plan are subject to tax deductions and you have to pay 10% penalty. Obviously, you get considerably smaller amount and also have to forgo tax-deferred growth of your assets. You can not pay back the amount of withdrawals from 401K plan after it has been disbursed.

401K withdrawals for non-financial hardships

You may be facing one of the following non-financial hardships and wish to exercise the withdrawal. Remember that these non-financial hardship withdrawals are also subjected to taxes. However, 10% penalty is waved of on such withdrawals.

• You have become permanently and totally disabled. You have been ordered by a court of law to pay the amount to your dependent, divorced wife or a child.
• You have excessive medical debts. Generally, withdrawals under this clause are permitted when you have medical debts that exceed 7.5% of your gross income.

• When you leave the job, your job has been terminated, retire early or permanently laid off or. When you have maintained payment schedule of regular withdrawals of your natural life. After you obtain the first withdrawal you have to continue taking the withdrawals for longer period, either five years or till you attain the age of 59-1/2 years.

• You leave the job, you retire early, your job has been terminated or you have been laid off permanently in the year you attain age of 55 years or later.

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Category: 401k Plans · Retirement Plans

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