You might be wondering whether or not you should consider withdrawing your 401K funds early. For example, let’s say that someone wants to get involved in the real estate market and are wondering if an early 401K withdrawal I a wise idea. This is often referred to as a “hardship” withdrawal.
If you’re considering the issue strictly from an accounting/investment viewpoint, then it might seem like a bad idea. In a sense this is true, but it's more complicated than just concluding that withdrawing the money early is unwise because you'll be losing money. So what's it all about?
There's a lot of evidence that supports not withdrawing the funds. For example, the cost of withdrawing the 401K early is very expensive. Another issue is if you're going to take this step it might be a good idea to improve your financial situation before getting involved in the real estate business.
It's probably best to put it this way. If you're going to make a 401K withdrawal, the costs are very high in the short-term. There are many issues to consider including the following ones:
1. Lost Earnings
This is the hidden cost that you should consider when determining whether or not you should withdraw your 401K. Such forgone earnings can be quite high in the short term even though they're a hidden cost. This is a very real issue when referring to withdrawals from requirement accounts. The effect on your finances can be huge.
However, keep in mind that this is generally in the short term. It greatly depends on how you re-invest your capital and the interest rate you'll get. The total cost can be quite high, and unfortunately, there's no real way to avoid the costs. It’s also highly unlikely you can earn your money back, which is another issue to consider.
If you withdraw your 401K early, you have to pay the marginal tax rate as well as a penalty rate (10%). Many people wrongly think that the withdrawal won't involve a penalty if a person’s first house is being purchased. This exception is indeed true for withdrawals of IRAs it doesn’t count for 401Ks.
One issue to consider is that taxes wouldn’t be paid on the withdrawal until April 15 during the next year. If the money was invested until then the investor can keep receiving earnings from the funds. However, the situation is a little more complex than that. So it’s important to consider all the facts and figures related to the tax issue before deciding to withdraw your 401K.
One of the main reasons you should avoid an early withdrawal of your 401K is the cost is sky-high. The good news is there are some alternatives you can use instead. One solution is to stop putting money in your 401k and get your personal finances in check.
Another option is to borrow from your 401K. You have the option to loan the lower amount between half your balance or $50,000.
The third solution you have is to quit your job then roll the 401K account into an IRA account. This provides more flexibility and lets you pick low-cost funds.