The Downside of 401k Hardship Withdrawals and the Alternative
By: Ask Bill
Submitted: 2010-12-02 22:01:58 | Word Count: 702
Retirement funds are there mainly for a reason. It is basically a plan for your financial future especially for a time when you probably won’t be working anymore. Generally you start accumulating funds for your retirement once you start working and probably may not touch the funds until your retirement age. However, there may be circumstances that force you to dip into your retirement fund early especially if you are on the brink of bankruptcy. It may not always be easy to withdraw from your retirement fund but 401k hardship withdrawals are designed for such purposes. Basically you may be withdrawing from your retirement fund before you retire or reach the designated retirement age.
Many experts, however, may advice against 401k hardship withdrawals because although it may help your financial present it may also have quite an adverse effect on your financial future. Of course, there are not many instances where you may be allowed for an early withdrawal of your retirement funds. Generally, you may only do so if you are in need of immediate and significant financial assistance like paying for medical expenses or college tuition, avoiding foreclosure and covering for a family member’s funeral expenses. It is also advisable that you consider your retirement fund as a last resort and leave it untouched unless you have exhausted other means for your financial needs.
One of the risks of an early withdrawal of your retirement fund is the costs that come with it. You may be required to pay income tax on the amount that you withdraw and you may also be penalized for an early withdrawal. Generally there may be a 10% penalty and although it may seem like a small percentage the actual amount may even cause a dent in your existing funds. Another downside you might want to think about is that generally your 401k fund is protected from bankruptcy. So it might serve as a fallback should you have no other choice but to file for bankruptcy. If you use your retirement fund to avoid bankruptcy you may be exposing your financial back up to some serious risks. The amount you withdraw from your 401k fund may no longer be protected from bankruptcy.
If you are in dire financial need, you may want to consider other alternatives or a hardship program such as a loan provision from your retirement fund. That way, you may only be borrowing from your retirement fund instead of making a permanent withdrawal. You may not be required to pay income tax or penalty for taking a loan out of your retirement fund. Of course, the restriction is that you may only be allowed to borrow up to 50% of your fund provided it does not exceed $50,000. Just like any other loan, there may still be an interest for you to pay. However, the interest rate is often competitive according to the market rate and the money you pay will go back into your retirement account.
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One thing you might want to bear in mind is that your 401k fund should be used wisely and if you need to either withdraw or take a loan from it, it is advisable that you use it for serious debt hardship purposes. This is because your retirement fund is considered an investment that is supposed to grow over time until you stop working so if you use it for luxurious vacations and cruises you may be putting your retirement at risk. The rule of thumb is that you may have to pay back your retirement loan in five years so unless you have the discipline and means to do so it is advisable that you avoid taking up a loan from your retirement fund. Of course, you may also want to consider the fact that you probably may not accumulate any interest or compound during the five years repayment period.
Basically you may borrow or withdraw from your retirement fund only if the situation really calls for it. Experts may advice that you consider other loans and alternatives prior to deciding on a 401k loan. After all, you do have your future to think about.
