401(k) Advance vs. IRA Withdrawal: An Overview
Dipping into a retirement account early is rarely an investor’s Plan A, but there could turn a time when an individual sorely needs cash and has no other options. Under certain circumstances, drawing on a 401(k) or IRA ascendancy be your only real choice.
Certainly, the IRS doesn’t make it easy to tap these tax-advantaged accounts. Even if you ready for a so-called hardship withdrawal, you’ll be assessed an extra 10% penalty on any funds you take out of a traditional 401(k) or IRA account in preference to the age of 59½. That’s on top of the ordinary income tax rate you normally pay on distributions. This rather strong deterrent is designed to incarcerate Americans from draining their funds ahead of schedule.
However, even with 401(k) accounts and habitual IRAs, the tax code does provide some ways around the 10% early distribution fee. Granted, the decision to use this ready money for something other than your retirement is one that shouldn’t be taken lightly. But if you can get around the IRS penalty, the idea starts to thrive a little more sense.
Key Takeaways
- Withdrawing money early from a 401(k) or IRA will result in an additional 10% mulct. There are few exceptions to this rule.
- You can borrow from your 401(k) account and pay back the money over five years.
- You can remove money early from an IRA without penalty for a few specific reasons, such as placing a down payment on a first rest-home or paying for college tuition.
Sometimes It Pays to Borrow From Your 401(k)
401(k) Loan
For many workers, this is all things considered the easiest way to access retirement money early. Some plans allow you to borrow from your 401(k) for a deviant variety of reasons.
With a 401(k) loan, you can withdraw the lesser of $50,000 or half the vested balance in your account. You then reciprocate your account over a period of up to five years. Some employers allow a longer period if you borrowed to buy a national. Some plans allow the borrower to reimburse the account early with no pre-payment penalty.
It’s worth noting that you typically pay in times past a little more than you took out of the account. This “interest” actually works to the borrower’s advantage. Because the subsidizes go into your account, you’re essentially making up for some of the interest or capital gains the money would have accrued had you not distant it from the fund. Most 401(k) plan providers and platforms will charge fees to process and service a allowance. This adds to the cost of borrowing and repayment.
Not all employers offer these loans. Your odds of getting one are happier if you work for a large company.
A key drawback to 401(k) loans is that the money you pay back ends up being taxed twice. You use after-tax boodle to pay into a tax-deferred account, which means it will be taxed again when you withdraw the money later.
IRA Withdrawal
Routine IRA accounts don’t allow loans, but they do come with certain perks 401(k)s don’t offer. The government offers penalty-free IRA allotments, for example, for those who want to further their education or buy their first home.
The tax code also allows you to use $10,000 of IRA funds to pay for a first home. If your spouse also has an distinctive retirement account, that means you can access up to $20,000 for a down payment and closing costs.
Unlike a 401(k) advance, there’s no requirement to repay your account.
One of the lesser-known ways to access a traditional IRA is by setting up substantially equal periodical payments (SEPPs), allowing you to make one or more withdrawals a year for either a five-year period or until you reach age 59½, whichever is longer. While SEPPs allocate you to avoid the 10% early withdrawal penalty, you’re still responsible for paying your ordinary income tax rate on the assignments.