When Can I Take Money Out of My 401k? | Personal Finance Analyst

30 May

piggybank Here’s a common question:

“When can I take money out of my 401k?”

It’s a question that’s been asked more than usual over the past year. Many people are watching 401k balances dwindle due to the big stock market dip while others are dealing with new financial stresses. When times are tight and you’re looking for money, that pile of cash in your 401k looks inviting.

But can you actually start yanking money out of your retirement plan? In some cases, you might be able to do that. In others, you could be stuck. It’s going to depend on your unique circumstances and the 401k policies your employer set up.

You can cash out your 401k when you retire. At that point, you pay the standard income tax rate on the dispersals. Obviously, though, most of the folks asking “When can I take money out of my 4o1k?” already know that they can have it once they retire. They’re more interested in whether or not they can get fast access to that money.

Generally speaking, there are two circumstances that will allow you to actually pull money out of your 401k plan.

First, if you terminate employment, die or become disabled. If you’re canned or finally scream “Take this job and shove it!”, you can get access to the dough. Termination of employment, regardless of whose idea it was, qualifies you to play with your nest egg early. If you die, the funds are available to your heirs. That probably isn’t part of your plan, though. If you become disabled, you can also get to the money. We don’t want that to happen, either, though.

Second, you can often take a chunk of your 401k money if you are experiencing a serious hardship. Many plans have caveats in them that will allow contributors to withdraw a portion of their 401k money under certain specific circumstances. The desire for a better television set does not qualify you for a harship exception. Nor does your bad decision to go on a spending spree with your credit cards. These early-access opportunities are reserved for those who end up facing serious medical bill problems or who may be waiting for the sheriff to come by with that foreclosure notice. If you can’t document a serious emergency, don’t expect to get your money out early. Even if you do, you probably aren’t going to be able to get more than a small percentage of the total funds in the account.

So, if you’re not quitting (or getting laid off) and you’re not staring down the barrel of a financial crisis unrelated to your personal debt obligations, how can you get to your cash?

To be honest, you can’t. Yes, it’s your money. However, in exchange for receiving any employer matching funds and the tax advantages associated with having a 401K, you give up some of your control over the money. It’s yours, but you can’t have it just because you’d like to hit the casinos or pay off the folks at Discover.

You may be able to secure a loan against your 401k, though. You’ll have to pay it back with interest, though. And if you happen to lose your job before repaying the loan, the balance will suddenly become due in full. It’s not a dream scenario to take out a loan this way, but it is sort of a roundabout way of getting your money in your hands. Oh, and you’ll only be eligible for a loan representing a fraction of your total balance.

So, that’s how you can do it. The bigger question is if you should do it at all. Generally speaking, the answer to that is a resounding “no”. They’re going to automatically hold back a percentage to cover the income taxes on your cash out and you’ll also get hit with additional penalties for pawing that cash before hitting retirement age. Usually, that combination of disincentives is reason enough to leave your money in place until you retire.

(NOTE: We keep using the word “usually” for a reason–many of the answers to this post’s questions can only be determined with certainty after carefully reviewing the rules of your specific plan.)

“When can I take money out of my 401k?” When you quit or get fired. When you’re facing a serious economic hardship or when you retire. That’s about it, unless you count taking out a loan.

In the end, however, you’re better off not scrambling your nest egg. Leave your 401k money in place if you can. As Dave Ramsey apparently said:

QUESTION: Chad and his wife have $35,000 in debt between credit cards, student loans and car loans. They bring home $150,000 a year. They also have $25,000 in their 401-K savings. He wants to (pay off his debt). Should they use that money to eliminate their debt?

ANSWER: You should not take the money from your 401-K to eliminate your debt because $14,000 will go to penalties and taxes – that’s 40% of your savings. It’s like taking out a loan with 40% interest to pay off your debt. That’s a bad plan.

Live on less for one year, get on a written budget, and you can have it all paid off in less than a year.

I would never cash out retirement savings to pay off debt unless it is to avoid foreclosure.