Exploring the 401(k) Rules in Times of Financial Trouble
Money is a strange creature. We need it to live but many people prefer not to think about it, even when life is going well and a steady paycheck is the norm. When things get stressful – moving, divorce, job loss – people want easy fixes and easy answers. They want money to solve their problems. If you’re in a bind like that, you might be tempted to cash out your 401(k) or, as a seemingly sound fiscal move, take a loan against your 401(k).
Both are usually bad moves and here’s why: if you cash out your 401(k), you can expect to get about 60% of your money. The rest will be eaten by taxes and penalties. If you take a loan against your 401(k), best case scenario is that you reset the clock on your retirement investing. Worst case, you end up owing every penny all at once if you lose your job for any reason.
Let me explain this scenario in detail. First, cashing out the 401(k): You think you need the money. Of course you think you need the money. Your life feels chaotic right now. Changing jobs, moving to a new city, getting a divorce, losing a job…. All of these are serious life situations. But cashing out your 401(k) to deal with the turmoil can be foolish in the long term. To keep the math simple, let’s say that you have 
$10,000 in the 401(k). First, you will owe Federal taxes on the money – let’s round that figure to 25%. So now your $10,000 is $7,500. Next you owe a 10% penalty for “early withdrawal.” So now you have $6,750. And don’t forget state taxes. They’ll whittle another chunk off the original figure, too. In the end, you have a little over $6,000 to use for this emergency.
Next, taking a loan against your 401(k): First and foremost, you are incurring a huge risk. Is your job secure? Can anyone, especially these days, say that they will still be at this job in five years? That’s what you have to be able to say before you should consider a loan against your 401(k). It’s a stipulation that most people gloss over when considering a decision like this. If you lose or leave the job, the loan is due within 60 days. That’s how most 401(k) plans operate. If you default on the loan you pay taxes on the full amount. It doesn’t ding your credit score, but that is small comfort when you’re looking at that bill.
Bad things do happen and we all find ourselves strapped for cash sometimes, but I hope I’ve made a good case that your 401(k) should not be considered an ATM machine, even if it is your money. Best to leave the money alone and let it do its job. Let it grow and mature and when you are ready to retire, it will be there.
What about in the case where the federal government ie the Obama administration is considering issuing worthless ious in place of my hard earned $80k. I can’t withdraw I have a steady job been there 12 years would not a loan make sense to take it and pay off cc debt , buy gold and emg food stuffs to last a while i was thinking maybe $20-25 k or should it be more?
May 11th, 2010 atHi Mark, Ok first I am NOT a certified counselor so if you want real advice do check with a financial planner. What I can give you is common sense. I would NOT borrow against my 401k, at least not right now. Is your job rock solid? 12 years is a long time, but these days….. Any chance you could lose the job or shift to another job? If so then you WILL be required to repay the loan within 60 days. Or you get taxed on the amount.
As to borrowing and paying off debt, I totally get you there. Being debt free is a great feeling and puts you in the driver’s seat. How much is in your 401k? How much do you bring home every paycheck? I mean, 20K could be a couple of pay checks to you or half a year’s salary. That’s an important factor. I am risk adverse and I don’t think that borrowing against the K is EVER a good idea.
As to buying gold…. I have friends, including friends who have guest posted here, who are bullish on gold — literally! They want to have something tangible and they think gold is it. I say to each his own, BUT this is not a route I would ever take. Gold fluctuates and if you think it is a hedge against inflation, think again.
Money, money as we think of it, needs to flow and your hedge against inflation has two parts: being out of debt and investing. Your biggest wealth building tool is your paycheck! Where does your money go every month, Mark? You may already have a written budget, but if not, see where the money goes. Maybe you can find where you spend $300 a month on eating out and if you could eliminate that expense, the $300 can go to paying off your cc debt. How much debt do you have? Getting out of debt should hurt a little so that you NEVER do it again. If you can wave a magic wand and it disappears then there is nothing to stop you from building the debt up again.
Once you are out of debt, then you can look at all sorts of investments and if gold still seems like a good idea, then you should go for it. Why? Because you will be in a position to take risks. (Would you gamble your life on the roll of the dice? That is what you are talking about.) But borrowing against your 401k to buy gold and emergency food is really no different than borrowing against your 401k to buy a car — the goods that you spent the money on are not going to be worth the money you spent. In other words if, two days after you bought them, you wanted to resell them to recoup your money, I doubt that you could get the same price. You would lose money in the deal. Maybe in the long term the gold will increase in value, but take a look at the long term history of gold — it is not a money maker.
May 13th, 2010 atGreat post!
June 4th, 2010 atIt looks to me that a lot of the everyday person is no much worse off in comparison with the genuine United states govt though the fed government will get to play by totally different laws. The government could take care of their unpaid debt by publishing money and their particular particular negotiation tactics are protected by way of the biggest army in the world.
June 10th, 2010 atVery interesting post thank you for writing it I just added your blog to my favorites and will be back
By the way this is a little off topic but I really like your blogs layout.
July 8th, 2010 atinteresting post indeed =)
July 27th, 2010 ati owe about $19000 that i borrowed against my 401k and cant roll it over into my new employers plan for 1 year how much would the tax be on the amount i owe? i have a total vested balance of about 105,000 and that total includes what i owe t’words the loan and can i go to the credit union and roll this over into say an IRA or what would be the recomended way to go
September 28th, 2010 atHi Lonerider, It is worth talking with your old employer about the loan, but I think the 60 day repayment is a solid fact. If you cannot pay back the 19k, you will owe taxes on that amount. How much tax depends on your tax bracket. Check with an accountant to get an estimate on the tax hit. Now, this presupposes that you CANNOT pay back the loan. If you can, pay it back and avoid the tax and the penalty.
September 29th, 2010 atI would do a rollover to the IRA, but that is just my opinion. I am not a certified financial adviser — ask the credit union adviser what he or she would recommend. I am a fan of the rollover so that you can keep up with contributions instead of having your retirement fund lie fallow for a year.
Can I take a loan against a Rollover IRA at an independent financial institution? The money in the Rollover IRA is an accumulation of past 401 K’s from previous employers.
September 29th, 2010 atHi Kim, Good question! To my knowledge the loan against 401k is truly applicable JUST with a 401k account. Please check with the firm you are using for your IRA — they will have the final answer. The reason I am (fairly) sure that you cannot take a loan against an IRA is that there are no provisions to ensure repayment. With a true 401k, the employer has control over the repayment structure and the government has the back up of charging you taxes if you fail to repay before you leave the job.
It is hard to say, since I don’t know what you want to use the loan for, but you should talk with your local credit union about a loan. I know 401k loans can be attractive since there’s no credit check, etc, but explore your options.
September 30th, 2010 atI like this article.. This is my first trip to this site. Thank you for sharing. I will revisit this site. I am a race car mechanic. My repair tip of the week is: Please do not attempt a extremely difficult fixer by yourself. This will cost you more money in the end. Thanks again..
November 6th, 2010 atI have moved to a new job. I have about 17K in my 401k and am cashing it out. I owe the government 22K, I want to know if I cash out the 401K will the government take my check. I am set up on monthly payments.
April 18th, 2011 atHi John, I have to plead ignorance on this issue. It would not surprise me if they took the money as partial payment, but I have no idea how it might go. You should contact the IRS or get the help of a CPA. Good luck!
April 19th, 2011 atI have a 401K plan with Fidelity.
I have zero debts and this includes: no mortgage, no credit payment, no credit card.. nothing..
I have a large amount in my 401K and am getting nervous now that Obama and his happy band of socialists are hell bent on making the dollar worth the same as Monopoly money.
Anyone got any ideas on what to do with my 401K… I don’t want to cash it in, but rather to try and roll it over to something that will stand the test of an economic catastrophe.
I was thinking about Gold??
August 8th, 2011 at