Thinking of taking money out of a 401(k)?

Here's what you need to know about 401(k) withdrawals and loans—plus alternatives.

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Key takeaways

  • Explore all your options for getting cash before tapping into your 401(k) savings.
  • Every employer's plan has different rules for 401(k) withdrawals and loans, so find out what your plan allows. In most cases, loans are an option only for active employees.
  • If you're thinking about a 401(k) withdrawal, a 401(k) loan is likely a better option, if it's available.
  • If you opt for a 401(k) loan, take steps to keep your retirement savings on track so you don't set yourself back.

No one opens and contributes to a 401(k) expecting to need their hard-earned savings before retirement. But if you're in a pinch, and no other sources are available, your 401(k) could be an option. The key is to keep your eye on the long-term even as you deal with short-term needs, so you can retire when and how you want.

Let's look at the pros and cons of 401(k) loans and withdrawals—as well as alternative paths.

401(k) withdrawals vs. loans: What's the difference?

401(k) withdrawals: If your plan allows it, you can withdraw your money before retirement. One route is a hardship withdrawal, which lets you take money out of your 401(k) if you meet IRS standards for "an immediate and heavy financial need." This could include major medical expenses, funeral expenses, or avoiding foreclosure on your home. Get the details from the IRS. While a hardship withdrawal is one type of withdrawal, your plan may allow withdrawals for other reasons—it depends on your plan rules.

Pros: You're not required to pay back withdrawals.
Cons: A withdrawal can have a big impact on your retirement savings. It permanently removes the money from your account. Also, you won't get the full amount of the withdrawal because of taxes and possibly penalties—20% of the withdrawal amount will be automatically withheld to cover your federal taxes. If you're under 59½, you'll also owe a 10% penalty, unless you meet strict standards for an early distribution. Among them: having a permanent disability, an IRS levy, or medical debt above 10% of your income.

401(k) loans: With a 401(k) loan, you borrow money from your retirement savings account. Depending on what your employer's plan allows, you could take out as much as 50% of your savings, up to a maximum of $50,000 within a 12-month period. You'll have to pay that borrowed money back, plus interest, within 5 years of taking your loan, in most cases. Your plan's rules will also set a maximum number of times you're allowed to take 401(k) loans.

Pros: Unlike 401(k) withdrawals, you don't have to pay taxes and penalties when you take a 401(k) loan. Plus, the interest you pay on the loan goes back into your retirement plan.
Cons: If you leave your current job, you might have to repay your loan in full in a very short time frame. If you can't repay the loan for any reason, it's considered defaulted, and you'll owe both taxes and a 10% penalty if you're under 59½. You may owe more when you file your tax return, including any applicable state taxes. You'll also no longer be investing the money you borrow, so you'd miss out on potential growth that could amount to more than the interest you'd repay yourself. What's more, you're paying back the loan with after-tax money, and that money will get taxed a second time when you withdraw it in retirement.

Is it a good idea to borrow from your 401(k)?

Using a 401(k) loan as an emergency fund or for elective expenses like vacations, parties, or gifts isn't a healthy habit. In most cases, it would be better to leave your retirement savings fully invested and find another source of cash.

In other cases, borrowing from your 401(k) might not harm you long-term—and could even help. For example, using a 401(k) loan to pay off high-interest debt, like credit cards, could reduce the amount you pay in interest to lenders. What's more, 401(k) loans don't require a credit check, and they don't show up as debt on your credit report.

Another potentially positive way to use a 401(k) loan is to fund major home improvement projects that raise the value of your property enough to offset the fact that you are paying the loan back with after-tax money, as well as any foregone retirement savings.

If you decide a 401(k) loan is right for you, here are some helpful tips:

  • Pay it off on time and in full
  • Avoid borrowing more than you need or too many times
  • Continue saving for retirement

It might be tempting to reduce or pause your contributions while you're paying off your loan, but keeping up with your regular contributions is essential to keeping your retirement strategy on track.

What are alternatives?

Because withdrawing or borrowing from your 401(k) has drawbacks, it's a good idea to look at other options and only use your retirement savings as a last resort.

A few possible alternatives to consider include:

  • Using HSA savings, if it's a qualified medical expense
  • Tapping into emergency savings
  • Getting a 0% interest credit card
  • Using other nonretirement savings, such as checking, savings, and brokerage accounts
  • Using a home equity line of credit or a personal loan
  • Withdrawing from a Roth IRA—these withdrawals are usually tax- and penalty-free

How do you take a withdrawal or loan from your Fidelity 401(k)?

If you've explored all the alternatives and decided that taking money from your retirement savings is the best option, you'll need to submit a request for a 401(k) loan or withdrawal. If your retirement plan is with Fidelity, log in to NetBenefits®Log In Required to review your balances, available loan amounts, and withdrawal options. We can help guide you through process online.

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