What is a 401(k) loan or hardship deduction? what you need to know

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Sometimes life throws a difficult, unexpected (and costly) event your way and you wonder how you’re going to pay for it. Hopefully you can rely on the money you set aside in an emergency fund to cover your expenses, but if you don’t have enough (or any) there, you may be looking for an alternative solution.

If you have a 401(k) account through your employer, one option you may have is to take out a 401(k) Hardship Loan or use a 401(k) Hardship Withdrawal to offset some of those expenses finance.

However, it’s important to note that you should exhaust all of your other options for extra money first before turning to a 401(k) loan. That means exploring any emergency funds you might have set aside, delve into extra savings, or even see if it’s possible to take on a side job that will cover the cost of what you have to pay. Because when you borrow from your retirement account, you rob the money of its potential to keep growing over time — especially if you withdraw all of your balance.

Here’s what else you need to know about taking out a 401(k) loan or 401(k) hardship withdrawal.

How 401(k) loans work

A 401(k) loan allows you to borrow money from your Company pension account on the condition that you repay the borrowed amount with interest. The good news is that payments and interest go straight back into your account.

The interest rate you pay on a 401(k) loan can change over time. Corresponding Debt.org, the interest rate you would pay on a 401(k) loan is usually a notch or two above the lending rate used by banks. The interest rate used by banks is called the base rate and is influenced by the Federal Funds Rate, so it can change over time. So if the base rate is 5.2%, the interest rate you pay on your 401(k) loan can range from 6.2% to 7.2%.

Because your 401(k) account is an employer-sponsored account, you must follow your employer’s plan rules regarding taking out a 401(k) loan. Many employers have limits on how much of your balance you can borrow and how many credits you can take out of your account per year – you’ll need to check the policies surrounding your employer’s plan before taking the next steps to borrow from your 401 (k).

Keep in mind that if you quit your job before paying off a 401(k) loan in full, you may have to pay back the borrowed money immediately (or at least over a much shorter period of time).

What about 401(k) hardship withdrawals?

401(k) loans are not to be confused with 401(k) hardship withdrawals. A hardship withdrawal is not a loan and does not require repayment of the withdrawn amount from your account. You’ll pay income tax if you make a hardship withdrawal and possibly the 10% early withdrawal fee if you withdraw before age 59. However, the 10% penalty can be waived if you can show that the money is being used for qualified hardship, such as: B. medical expenses, or if you have a permanent disability.

Another key difference between the two is that with 401(k) hardship withdrawals, you wouldn’t be able to pay yourself back what you took out of your account. This is not the case with 401(k) loans.

Eligibility for a 401(k) hardship deduction depends on your plan and the rules of the plan administrator, so be sure to check how you can qualify for one.

alternatives to financing

Overall, you should only borrow from your 401(k) after you’ve exhausted all other financing options, because if you’re taking money out of your 401(k), it means it’s you prevent it from growing the most over time. You’ll miss out on the power of compound interest when you withdraw money from your retirement account.

If you need money to cover an expensive, unforeseen event that is making you stressed, the first thing you should look for is your emergency fund. After all, that is the purpose of your emergency fund. It’s usually recommended that you keep your emergency funds in a high-yield savings account — like that of Allied Bank or Marcus from Goldman Sachs – as these usually earn more interest compared to a traditional savings account.

If you don’t have an emergency fund, you might consider turning to other savings you’ve set aside.

Ally Bank online savings account

Ally Bank is a member of the FDIC.

  • Annual Percentage Return (APY)

  • minimum balance

  • monthly fee

    No monthly maintenance fee

  • Maximum Transactions

    Up to 6 free withdrawals or transfers per billing cycle *The 6/extraction cycle withdrawal limit is being waived during the Coronavirus outbreak under Regulation D

  • Excessive transaction fee

  • overdraft fees

  • Offer checking account?

  • Offer ATM card?

    Yes, if you have an Ally checking account

Marcus from Goldman Sachs High Yield Online Savings

Goldman Sachs Bank USA is a member of the FDIC.

  • Annual Percentage Return (APY)

  • minimum balance

    None to open; $1 to earn interest

  • monthly fee

  • Maximum Transactions

    Up to 6 free withdrawals or transfers per billing cycle *The 6/statement withdrawal limit is being waived during the Coronavirus outbreak under Regulation D

  • Excessive transaction fee

  • overdraft fees

  • Offer checking account?

  • Offer ATM card?

US Bank Visa® Platinum card

On the safe side of the US bank

  • Reward

  • welcome bonus

  • Annual fee

  • Introduction APR

    0% for the first 20 billing cycles on balance transfers and purchases

  • Regular APR

    15.24% – 25.24% (variable)

  • transfer fee

    Either 3% of the amount of each transfer or a minimum of $5, whichever is greater

  • foreign transaction fee

  • credit required

Wells Fargo Reflect℠ card

On Wells Fargo’s secure website

  • Reward

  • welcome bonus

  • Annual fee

  • Introduction APR

    0% introductory APR for 18 months from account opening on purchases and qualifying balance transfers. Introductory APR renewal of up to 3 months with on-time minimum payments during introductory and renewal periods; Balance transfers made within 120 days qualify for the introductory rate

  • Regular APR

    13.74% to 25.74% variable APR on purchases and transfers

  • transfer fee

    Introductory fee of 3% (minimum $5) for 120 days from account opening, thereafter up to 5% (minimum $5)

  • foreign transaction fee

  • credit required

If the expenses you are trying to cover are medical expenses, it might be a good idea to withdraw from your Health Savings Account (HSA) if you have one. HSAs are an investment account intended for medical expenses. You make pre-tax contributions to the account, your balance grows tax-free, and you owe no taxes when you make a payout for qualifying medical expenses. This is the triple tax benefit that comes with this type of account, and it allows you to avoid going deeper into debt to pay for all or part of your medical expenses.

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Editorial note: Any opinion, analysis, review, or recommendation expressed in this article is solely that of Select’s editors and has not been reviewed, approved, or otherwise endorsed by any third party.

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