Seeking Facts/Advice on If a 401(k) Withdrawal Became Necessary

June 26, 2008 11:21 AM

I would like to know a few things about withdrawing (not loaning, but flat-out withdrawals) from 401(k) funds.

Rest assured that I ask these questions knowing it is a very bad idea, and that I am asking only for the purposes of having knowledge in hand of potential assets for an entirely unforeseen financial catastrophe.

Should the financial course I've set for myself proceed well, I should have an adequate larger-scale emergency buffer through other means by hopefully mid-2009. However, until then, I have no buffer for larger-scale emergencies, and this disturbs me.

I have counseled others on Ask Mefi who are contemplating withdrawing from their 401(k) to pay off their debts, or for other reasons, that they shouldn't. I still feel this way, so I need not be convinced by others it's a bad idea. I am asking this not for any light purpose but simply so that I have the specific knowledge should there be an utter financial catastrophe — I would touch my 401(k) funds only in such a catastrophe. (Also, I am assuming, for the sake of this theoretical catastrophe situation, that at the time of said catastrophe I have no other methods of credit, income, or savings which I can hit before this, including 401(k) loans, as this would be a worst-case scenario.)

Let's say I had $20,000 in a 401(k) fund. (That is not the amount I have. I'm just throwing it up there as a round figure to work with.)

(1) Can one effect a partial 401(k) withdrawal, or is it all or nothing?

(2) How do I take the amount of withdrawal, whatever that is -- partial or whole -- and from there figure out how much I will pay on it in taxes and penalties?

(3) Both government and corporations highly discourage 401(k) withdrawals. Are there any actual laws in place that would prevent withdrawals? Are 401(k) companies allowed to prevent you from withdrawals? In other words, is the procedure made especially difficult?

(4) Are there any non-emergency and/or non-catastrophic situations where it would nevertheless be a wise financial choice to withdraw from one's 401(k) funds?

(5) Anything else I should know?

posted by WCityMike to work & money (4 comments total)

The short answer is, a lot depends on your particular plan. The IRS has a hardship withdrawal FAQ that addresses some of your questions.
posted by magicbus at 11:56 AM on June 26, 2008

I did this last year after careful consideration in order to pay off my student loans. In my case it was advantageous because my student loan holder (the state of TN) was willing to to settle for 70% of the amount if I paid it off in one lump sum. This savings and the savings of future interest was more that the taxes and penalties that I accrued. I am not a tax or retirement specialist, I am answered from my experience, and what I was told at the time. YMMV.

1) I think this depends on your particular plan. The 401k I withdrew from was from an employer I no longer worked for. I was able to make a partial withdrawal (that ended up being about 75% of my total holdings.

2) You call up the company managing you plan. Mine was Fidelity. I talked to someone who helped me calculate the taxes and penalties. With most (if not all) 401k's the amount you with draw is taxed at the time of withdrawal although I can't recall at what rate. (To avoid this I rolled it into a Roth IRA, and then made my withdrawal, and which allowed me to wait until tax time to pay up). And whatever you withdraw is also considered taxable income, it can put you in a higher income tax bracket overall. The penalty is a flat 10%, but there are some exceptions- buying a house and education expenses. I was able to forgo the 10% because I was paying off student loans.

3). No laws (just penalties)... and not difficult at all. Seriously, the guy at Fidelity didn't blink. I think this is very common.

4.) See my above example. I guess there is an argument to be made for hurting myself down the road, but in my case getting out from under the burden of student loans had lots of other benefits. Also, I didn't completely wipe out my 401k, I am fairly young (35), and I have now increased what I am contributing, so that I should be able to catch up down the line.
posted by kimdog at 12:01 PM on June 26, 2008

Lord, sorry about the typos... more than the taxes... I am answering
posted by kimdog at 12:03 PM on June 26, 2008

I did something much like Kimdog. Pulled a few thousand to clean up some nagging debt, get some home repair work done, and crank my 401k contributions back to where they were before I took on said nagging debt.

I only pulled about five or six percent of my total holdings. They took the 10% penaly right off the top, and I will have to pay additional taxes come next April. So, to answer your specific questions:

1) Partial is allowed.

2) It's a 10% penalty plus whatever your percent tax is on the entire amount.

3) I thought it was scary easy, like it could get to be a really bad habbit if you weren't wise. In my case I had to request and information package and then there was a couple weeks manditory think about it time, though I had already thought about it for a couple weeks.

4) How important is whatever you're going to do with the money? I figured I set my savings back a year or so, but I have more financial headspace; re-maxed my 401k contributions and have gotten rid of some nagging debts and other lifestyle stresses. I'd do it again.

If you're 55 and going to completely deplete your 401k to buy a sailboat, you'd better not really need a 401k or really enjoy dogfood.

5) Not really. It's a retirement savings plan with some tax perks. Don't go crazy and you should be OK.
posted by Kid Charlemagne at 3:18 PM on June 26, 2008