When you're under 59 1/2 years old, the only guaranteed way to access your 401(k) funds legally is to leave your job, but don't jump ship just yet. Depending on the terms of your plan, you might be able to take a hardship distribution or borrow from your 401(k). However, the Internal Revenue Service leaves those options to the discretion of each 401(k) plan, so you might be out of luck.
Your 401(k) plan may permit withdrawals if you have an immediate and heavy financial need that you can't satisfy with other resources. Examples include mortgage or rent payments to avoid eviction, costs of medical care or a home purchase. Usually, according to the IRS, you can't take out more than you've contributed to the plan, not including contributions your employer made on your behalf or the earnings on your contributions.
Hardship Withdrawal Tax Implications
Though a hardship withdrawal might sound justifiable, it's not going to help you come tax time. Like all other withdrawals, you're still on the hook for income taxes on the distribution. Plus, hardship withdrawals are still hit with the 10 percent additional tax penalty when you're under 59 1/2 years old. Exceptions that will get you out of the penalty (but not regular income taxes) include suffering a permanent disability, medical expenses exceeding 10 percent of your adjusted gross income or the IRS levying on your 401(k) plan.
Your 401(k) plan also might permit you to borrow money from your account -- and you won't need a financial hardship to do so. The IRS caps the amount you can borrow at $50,000 or half your vested account balance -- whichever is smaller -- and repayments can't exceed five years unless you're using the loan to buy a primary residence. Though the loans charge interest, that money goes back into your 401(k) plan, which may help make up for the investment gains you'll lose.
Loan Tax Consequences
If you repay your loan as agreed, the amounts borrowed and repaid won't affect your taxes at all because you're essentially borrowing your own money. However, if you default on your loan, the tax consequences can be nasty. Any unpaid balance on the loan counts as taxable income in the year of default and, when you're under 59 1/2, also gets hit with the 10 percent early withdrawal penalty. For example, if you default with $3,500 left on your loan, you pay income taxes on $3,500, plus a $350 penalty.
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