401k Loan Or Early Withdrawal?
Posted By tsauthor on October 27, 2009
If you ever need to get money out of your 401k retirement plan early there are two ways to do it. You can make a simple withdraw or you can take a loan out of your account. Each method is better for different situations.
If you decide to take an early 401k withdrawal you can be hit with a 10% penalty for any money you take out and you will also have to pay taxes on that money.
The good news is that you will get cash now, which can be very helpful during certain times in our lives. The bad news is that a good percentage of that cash will have to be used to pay taxes and penalties. Once more any cash that you take out of your 401k will not be enjoying the returns they would be if they were still invested
In other words withdrawing $20,000 today could mean that you will have $60,000 less when retirement comes around, because of the interest you would have been earning off that money. Obviously that is something that would be better if it could be avoided
Another way you could take money out of your 401k is by taking a loan. This is simply a loan you are borrowing from yourself which you will have to pay back with interest.
These loans are very popular because no one needs to check your credit report and you do not need to worry about not being approved. a 401K loan will also normally have a much smaller interest rate then you will get with other lenders.
But be warned these come with a few 401k loan rules which can make taking a loan out very painful to your financial future. The greatest disadvantage is that you might not be able to deposit more money into your account or the amount you can deposit will be greatly reduced, until you repay the loan.
This could seriously hurt you in the long term, especially if it is going to take you the full 5 years to pay it back. For instance let?s say you are depositing $10,000 a year into your 401k. If you take out a loan for 5 years that means that you will not be able to deposit money for 5 years. That would be $50,000 that you would miss out on, and that is not including the interest you would have made on that money.
So, which method better? Well hopefully you never have to think about it but it depends, based on a number of factors such as how long it will take you to payback a loan and if you can even afford to take on another loan.
If it will take you 5 years to pay back the loan and the added expenses will really affect you, you might be better off by simply making a withdrawal.
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