You know the deal: Start saving now, not later, for retirement. So you’ve put a little bit of your paycheck aside every period since you graduated and taken advantage of any employee matches available. Amazing.
But now something’s come up and you need cash fast. Your car got totaled; you finished a grad program and have tons of debt to pay off; or you have an impacted tooth and the dentist’s going to charge you one billion dollars to deal with it. Life happens.
So what about that compounding pot of money you saved for retirement a.k.a. your 401(k)? It’s just going to be sitting there for the next 30 or 40 years. You need cash now! So why not yoink some of your savings? You have plenty of time to replenish the stockpile.
No. Plz don’t. Alarm sounds. Much regret.
Toneisha Friday, the founder and executive director of Coin Financial, puts it plainly: “Never cash out your 401(k).” Marshay Clarke, a certified financial planner at Betterment, agrees: “Don’t disrupt the assets.”
The good news is you can still use your 401(k) to give you a little financial leverage. Just not in the way you might be thinking. Here’s what the pros say.
Why is taking money out of my 401(k) a bad idea?
There are a number of reasons, but here are the main ones.
1. You have to pay additional federal and state income tax when you take that money out.
2. If you’re younger than 59 and a half, you have to pay an additional 10 percent early withdrawal penalty.
3. Your 401(k) interest growth is gonna be way lower when you have less money in your account.
“You’ll be hit with a bunch of fees that might seem low now, but they’ll become unbearable because you won’t have cash flow in your 401(k),” Friday says. You should *especially* never take money out of your 401(k), Clarke says, for an optional expense.
So what do you suggest I do then? I seriously need cash.
If you’ve exhausted the usual options—such as getting a no-interest credit card, selling your old stuff, side-hustling, assuming a false identity and swindling money from your loaded pals(jk)—then you may want to consider taking a loan against your 401(k).
“When you request a loan from your 401(k), you typically pay a very small amount of interest, between 4 and 5 percent,” Friday says. “If you were to take a loan from a bank that’s not connected with your 401(k), the interest could be upward of 25 percent.” Then, when you’re ready to repay your loan to your 401(k) a.k.a. your loan from your future self to your present self, you can do it with pre-tax money, through your paycheck.
Borrowing against your 401(k) doesn’t go on your credit report, which is awesome.
When would it make sense to borrow from your 401(k)?
According to Friday and Clarke, good times to borrow from your 401(k) could be when you:
1. Buy a home and need a big lump sum of money.
2. If you’re trying to pay down your student debt and have very high interest rates that are hurting you and affecting your credit.
3. If you want to consolidate your debts. For instance, if you have less than $5,000 in credit card debt, borrow from a 401(k) and pay it off. That way, you’re paying ~4 percent interest on your 401(k) loan to yourself rather than ~20 percent interest on your credit cards.
4. You’re in a dire situation, like you owe the IRS money in back taxes or you’re going into bankruptcy.
Just remember, there’s a limit to the amount you can borrow from your 401(k): either $50K or 50 percent of its balance, whichever one is less. And it takes about a week to hit your account.
I just graduated. I have a ton of student debt and no money in my 401(k) yet. Do I put money into my 401(k) first or pay off my student loans first?
If you have private loans with high interest rates, pay those first, Friday says. But see if you can still contribute a small amount, even 2 or 3 percent, to an interest-bearing savings account and, later, your 401(k).
“Regardless of whether you have a million dollars in debt, you need to have some kind of emergency fund, because if your tire goes flat and you need to buy a new one, you need money to pay for that. So whether you save in your 401(k) or start a separate interest-bearing savings account, you need to have something on the side,” she says. Clarke also underscores the importance of an emergency fund, saying, “You need to have a piece of money to draw down from.”
In a perfect world, you’d have both an emergency fund and a 401(k) set up. “You need to fine-tune how much to put in each,” Clarke says. “If you’re maxing out your 401(k) every year, but you have no emergency fund, that’s not the right balance.” An emergency fund is a finite goal of three to six months of expenses, she says. After you reach that amount, you can start focusing on your 401(k).
Always speak to a licensed financial services provider or specialist before making decisions that could affect your financial wellbeing.