There are many times in your life when you could use a little extra cash. It could be because you’re buying a new home. Or maybe you’ve been laid off and need the money to help you make ends meet. Or perhaps your family member had a medical emergency and you want to help.
It’s easy to see why retirement savings accounts become shining buckets of cash in these situations. Today, I want to lay out some ways that you can take early distributions, and give you a couple of reasons to think twice about early 401k withdrawals.
When You Can Withdraw Early Without Penalty
- If you become permanently disabled, you can begin taking 401k distributions without penalty before age 59½.
- If you get laid off or lose a job and leave that 401k account with your former employer, you can start withdrawing funds from that account at age 55.
- Other reasons you may want to take an early withdrawals include: medical expenses, purchase of primary residence, education expenses, payments to prevent eviction or foreclosure, funeral expenses, or home repair costs. These situations would require you to apply for a hardship distribution and prove that you have an “immediate and heavy financial need.” This will also require you to work with your plan sponsor to get this exemption for you. Keep in mind, if you don’t qualify, you will need to pay the 10% early distribution penalty.
Why You Should Think Twice
While all of these things are important and are certainly understandable reasons to tap into your retirement funds, it does mean putting your retirement at risk. With the exception of a permanent disability which prohibits you from working, I want to offer up a couple of solutions that you should consider before tapping into your 401k.
The best options involve preparing ahead of time. A great option is preparing an emergency fund. I recommend people have about six months’ worth of living expenses set aside in case of job loss or a medical emergency. Another option, if you are qualified to own one, is to open a health savings account (HSA). This account will allow you to put away tax-deferred income which can be withdrawn tax-free for qualified medical expenses. That means you pay no tax when you put it in, the money is able to grow tax-free and then you can withdraw the money for medical need without paying tax then either. Keep in mind, these are only available to individuals who have a high deductible health plan (HDHP).
Other ways to plan ahead for these kinds of costs is to have proper insurance policies in place. If you or a loved one became injured or ill, a high quality medical insurance plan can help mitigate costs to help ensure you and your family can afford the care you need. It’s also important to have a quality insurance policy for your home. These kinds of policies can save you thousands in the case of storm damage, water damage or if your home is burglarized.
If you want help in figuring out if an early 401k withdrawal, or any other savings mechanism is right for you, reach out to your financial advisor. Your advisor should be able to help you navigate life’s ups and down, and can help you be better prepared for those financial rainy days.
This article was first published on 4/23/2017 in the Des Moines Register.
Jim Sandager has an extensive retirement income planning background and has written several personal finance columns for The Des Moines Register. Jim studied at the University of Minnesota and Bowling Green State University.