5 Questions to Ask Before You Take Money from a 401(k)

Sometimes even the most financially prudent individuals may go through an unforeseen emergency that forces them to consider making an early retirement withdrawal.

However, while in your moment of difficulty using your retirement funds may provide instant relief, it is important to ask yourself some tough questions before you choose this last-resort option.

Is the expense really unavoidable?

Undergoing an emergency medical procedure, fixing a leaking roof, or getting your car repaired so you can commute to work may be the legitimate expenses when you might think of an early retirement withdrawal.

However, if you are looking for kitchen remodeling, replacing your old HVAC, or financing a lavish wedding for your son, it may not judicious to use the money that you have saved for your golden years.

If it is possible to hold off or scale down the expense, do it by all means to preserve your retirement nest egg.

Do you have an alternative source of funding?

Considering the longer average lifespan, the growing costs of healthcare and general economic uncertainties, your goal should be to maximize your retirement savings as far as possible. If you are at a crossroads about whether to make an early retirement withdrawal, first explore and exhaust all other potential options to finance your immediate needs.

If you have an emergency fund or you can borrow money from a friend or family member at a reasonable cost, it might be good to use these sources rather than tapping into your retirement funds.

What is your age?

If you are thinking of withdrawing funds from your retirement accounts, such as 401(k) or IRA, you will have to pay a 10% penalty (plus any taxes you might owe) if your age is below 59½. Even if you have crossed this age limit, you will still be taxed on the distribution amount from these accounts.

However, if you have a Roth IRA account, you may withdraw money from it without having to pay any penalty or taxes on the distribution. But the pre-condition in this case is that you should have had this account for at least five years.

Does the distribution qualify for avoiding penalty?

Even if your age is below 59½, early withdrawal from your 401(k) or IRA retirement accounts may not draw the penalty of 10% under certain circumstances.

These include:

  • You are fully and permanently disabled
  • The IRA owner has died and you are the beneficiary
  • You will use the distribution to purchase, construct or reconstruct your first home
  • Your distributions are received in annuity form
  • Your non-reimbursed healthcare costs exceed 7.5% of your income
  • You are paying health insurance premiums while you’re unemployed
  • You will use the distribution to fund higher education
  • The early withdrawal is because of an IRS charge on the qualified plan

Have you consulted a financial advisor?

If you are in two minds about an early retirement withdrawal or you intend to withdraw a substantial amount, it may be helpful to talk to a financial advisor beforehand.

A reliable professional will be able to evaluate your financial situation more objectively and help you consider alternative solutions that work best in your circumstances.

Once you understand the pros and cons of different options for your financial future, you can make the right decision about an early retirement withdrawal.