Taking money from your 401(k) may seem enticing at a time like now, but there are a lot of things to consider before trying it.

Share story

Today’s economic environment can create a cash crunch when people face big expenses, such as unanticipated medical costs or the possibility of a home foreclosure.

In many cases, credit-card debt limits have been reached, and with declining home values, home-equity loans may not be an option to provide quick cash.

When situations like this occur, many are tempted to rely on what may seem the most readily available money — their 401(k) plan.

Hardship withdrawals from workplace-retirement plans are drawing more interest from investors.

Taxes and penalties may apply if you withdraw funds early, and there is little flexibility to avoid it. For instance, if you are in the 25 percent tax bracket, a withdrawal of $10,000 from your 401(k) will net you $6,500 in available cash after you pay taxes and a 10 percent penalty.

Because of that, and due to the fact you should be doing all you can to preserve your retirement portfolio, it may be best to avoid early withdrawals from your 401(k). Once retirement comes, you may not have opportunities to add more to your nest egg.

Early withdrawals could increase the risk that you may outlive your savings in retirement.

If your portfolio is performing somewhat in line with the stock market, selling during a market downturn is not typically recommended. For most investors, this has been a challenging period where the value of their 401(k)s has been declining.

It is also important to note that withdrawals can only occur under specific circumstances. According to the IRS, an early withdrawal qualifies as a hardship withdrawal if you are:

• Paying unreimbursed medical expenses.

• Purchasing a principal residence.

• Paying college-tuition costs for certain family members.

• Making payments to avoid a home foreclosure or paying for home repairs.

• Covering the costs of a funeral.

Even if you meet these conditions, you will not avoid paying tax and penalty on your withdrawals.

To preserve the integrity of your retirement plan and avoid the impact of taxes and penalties, you should consider alternatives to hardship 401(k) withdrawals to meet short-term financial needs.

One option is to take a loan from your 401(k) plan. Check with your employer to see if loans are an option within your plan. At the same time, use caution.

When you borrow from your 401(k), you repay the loan at interest rates that are often tied to the current prime rate, but the amount you took out of the account is no longer generating returns in your investment portfolio.

An important goal is to pay back the loan as quickly as possible.

If your employment should end, the unpaid portion of the loan is treated as a distribution, subject to taxes and possible penalties for early withdrawals.