401k beach sign - use your 401(k) without penalty before retirement planning farmington
  • By Emma Andrews
  • Posted June 1, 2020

How to Use Your 401(k) Without Penalty Before Retirement

For countless individuals, 401(k) accounts are retirement lifelines. It is essentially a tax-advantaged account that allows an individual and their employer to make contributions. Those contributions can be withdrawn for retirement and used to provide income during a person’s golden years. Due to their tax-advantaged status, you cannot normally make withdrawals from a 401(k) without financial penalty. However, there are some exceptions to this rule.

401(k) Business Loan

In certain instances, you can borrow against your 401(k) to start a business. According to Franchise Gator, the process is called the Rollover for Business Startups (ROBS). Doing so will allow you to cover the costs associated with starting the enterprise. Furthermore, this process is not a loan, and you don’t have to pay back the money that you withdraw. Instead, this is just money that you can use under the right circumstances. There is no interest to be repaid, and you don’t have to worry about a hit to your credit score due to this type of funding.

A Hardship Withdrawal

A Hardship Withdrawal is exactly what it sounds like. According to Plante & Moran, in certain circumstances — such as serious financial strain, unemployment or an unexpected expense — you can withdraw money from your 401(k). There are set definitions for what constitutes such a situation, and each plan has different rules, so it is better for you to check with your financial planner before making such a withdrawal. Furthermore, you have to actually prove that you will face a major income loss or rise in expenses, so don’t think you can simply invent a financial hardship. There is good news, though. If it meets the appropriate criteria, this type of withdrawal can be made without incurring a penalty.

Home Purchase

You can use your 401(k) to purchase a home. However, you have to meet certain criteria in this scenario as well. The amount you can borrow is limited to $50,000 or half the value of a home. Fortunately, this can be done without penalty or taxes, but it is considered a loan. That means you’ll have to pay the amount back with interest that is usually a little higher than the prime rate. You will typically have up to five years to repay the loan.

Although taking out a 401(k) business loan, having a hardship withdrawal, and purchasing a home are essentially free of penalties, they do come without potential financial complications. You should always check with your accountant or financial planner before deciding to make a withdrawal from your 401(k).

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