You generally can — many 401(k) plans allow you to borrow assets before you retire. Because rules vary from plan to plan, you should check with your plan administrator to be sure. But it may not be a good financial move.
If you need money for a large, immediate expense — and you don't have access to other funds — it can sometimes make sense to take out a 401(k) loan. But keep in mind that borrowing from your 401(k) account might be costly in several ways:
- Because the money you borrow will no longer be earning potential tax-deferred growth inside the account, you could potentially be missing out on significant profit.
- You'll have to repay the loan and make interest payments with after-tax dollars.
- Paying off the loan may mean you're unable to contribute as much to your retirement account as you normally would.
- In rare instances, some 401(k) plans won't let you make contributions until the loan is repaid.
Because the money you borrow will no longer be earning potential tax-deferred growth, you could potentially be missing out on significant profit.
It's important to understand the
possible effects an early withdrawal could have on your retirement account and your overall finances. "As with any financial decision, it's important to educate yourself on the pros and cons of each option before finalizing your plans," says Bill Hunter, head of strategy for the Retirement Client Experience at Bank of America Merrill Lynch.
Do I have to pay taxes on a 401(k) loan?
If you leave your employer before the loan is paid off, you may owe federal and state income taxes on the distribution — in addition to a 10% federal tax if you're under age 59½ — unless an exception applies. In 2018, the time period for rolling over outstanding loans to an IRA or a new employer's plan was extended. You may now have until your tax filing deadline for the year in which the loan was distributed to pay off the loan and avoid having it treated as a taxable distribution. Consult your tax advisor if you are considering this option.
How do hardship withdrawals work?
If your employer's plan permits them, you can apply for a hardship withdrawal, if, for instance, you're facing eviction or need to pay for certain medical expenses. Your withdrawal will typically be treated as taxable income, and you may not be permitted to make new contributions for a period of time following the withdrawal. Another consideration: a hardship withdrawal permanently reduces your retirement account balance and gives you no option to repay, which can make it difficult to get back on track with your retirement goals.