The current financial and credit crisis has put many households on the verge of survival. Being forced to live with an even tighter budget, many people have considered borrowing from or liquidating their 401k plans. And although 401k is not a savings account, more and more people are turning to it, requesting a 401k hardship loan. However, there are some important considerations that need to be addressed.
Solvency in retirement years is being put at stake
401k is a retirement plan that aims at ensuring solvency in the retirement years. Cashing out the 401k to pay off current debt is in the 99.9 percent of the cases a bad idea. The money you are saving today will be valuable in the years you won’t be able to work anymore. If in the future, you get sick and you cannot work past a certain age, you will need this money to fall back on. Unless there is a feasible plan to replace the money that is spent today, chances are there will be no money in the future at all. But there will be no option to work as well. And this will you’re your retirement years tougher.
You start over from the bottom
By liquidating 401k, in effect you start over from the bottom and the older you get the most difficult it becomes to rebuild a fund. Younger people can work at two jobs, have a stronger stamina and be more determined to achieve. As you get older, you lose your patience, your vision and, most importantly, your will to fight for establishing things. At an older age, you are supposed to enjoy what you have built at a younger age. And everything becomes harder without money.
Unemployment benefits are deferred when a 401k hardship loan is allowed
When you are allowed a 401k hardship loan, the government considers the money as income and when the whole amount runs out you are not eligible for unemployment benefits. People who have managed to collect unemployment and withdraw 401k funds were required to pay back the benefits received.
Liquidating is subject to severe taxation and penalties
If you liquidate your 401k before the age of 59 1/2, the retirement funds are subject to taxation and 10% penalty payment. This is another reason why young people should not consider liquidation of their 401k plans, but even if they do they should be sure to calculate taxes and penalties correctly with a tax preparer to avoid additional charges in their already difficult financial situation.
There also is an immediate cost when cashing out and it can deliver a really large bill on your door. As soon as you liquidate your 401k, your plan administrator automatically withholds 20% of your balance and sends it directly to the IRS to cover the taxes you may need to pay on that withdrawal. And of course, this is money that is no longer available for retirement.
The Bottom Line
By and large, there is no doubt that liquidating 401k plan before the retirement age is a bad idea. It may make financial sense today, but in the future, it can harm your financial health. 401k is perhaps the only way to get out of financial problems in retirement. By liquidating it or borrowing from it, you put yourself in a constant circle of debt, financial insecurity and insolvency.
Furthermore, there is an emotional weight that initiates when you start considering your 401k as ready-to-access money. The amount you are eligible to withdraw is viewed more like an additional source of income rather than your retirement account that will guarantee safe retirement years. For example, you withdraw today a certain amount from your 401k to cover for your credit card payments. After a few years, you to the same and after a few years again the same. By keep on withdrawing from your 401k, till you are 65 little will be saved for retirement. But you don’t realize this while withdrawing the money.