Taking money out of retirement savings with a 401(k) withdrawal or 401(k) loan may provide a financial lifeline in times of stress, but it does come with impacts that must be carefully considered.
A car blows a tire. An illness requires a hospital visit. A heavy rainstorm leads to a leak in the ceiling. Unexpected expenses, big and small, happen to all of us.
In an ideal world, we would all would have enough savings to cover those surprises. In the real world? Less than half of adults have three months of emergency savings tucked away.
Taking money out of a 401(k) early for uses other than retirement can have both short- and long-term consequences. For some, it may be the only solution, but understanding the impacts can help you better prepare your finances. Here’s what to know if you are thinking about taking money out of a 401(k) through a loan or withdrawal.
What is a 401(k) loan?
A 401(k) loan is just like it sounds: You take money out of your retirement savings—essentially making a loan to yourself—but agree to pay it back with interest, like any other loan.
You may not take a loan for the entire amount you’ve saved in a 401(k). Instead, your loan amounts are limited to one of two options:
- 50% of the vested balance or $50,000, whichever is less. (Your contributions are always vested but any employer contributions may not be, depending on your time of service with the company.)
- Up to $10,000 if the vested balance is $10,000
There are also time limits on repayment. You must pay it off within five years or before you leave your employer. Otherwise, you will be subject to taxes and penalties. However, the interest you pay as part of the loan is re-invested in your 401(k) account.
What is a 401(k) withdrawal?
A 401(k) withdrawal, on the other hand, is permanent; you choose to take money out of your retirement savings before age 59½ with no requirement or expectation that you repay it. This is sometimes called an early withdrawal, and it is subject to a 10% penalty and income taxes. However, there are some exceptions to the penalty charge and whether the plan allows for early withdrawals. (See more on hardships and emergencies below.)
Do all plans allow 401(k) loans and withdrawals?
No. If you’ve decided you need to take money out of your retirement savings, your first step is to check with your HR department or the plan service provider.
What is the impact of taking a 401(k) loan?
The biggest to-do is the repayment: You must include that monthly obligation in your budget for however long it takes you to repay the loan. (Yes, you can repay a 401(k) loan in less than 5 years, and sometimes sign up for automatic payroll deductions.) Here are some other considerations.
| Time it takes to receive a 401(k) loan | Varies, typically around a week or two |
|---|---|
| Number and total of 401(k) loans | Maximum number determined by plan; total loans may never exceed maximum loan limits detailed above |
| Taxes and penalties | Not a taxable event. No penalties, as long as loan is paid back within five years or before you leave your employer; otherwise it is in default and considered a distribution so you pay taxes and a 10% penalty if you’re under age 59½. |
| Interest | Rate varies; interest paid goes back to 401(k) account |
| Retirement savings growth | May lose potential growth from decreased retirement savings during loan repayment period |
| Credit score | Generally no credit check needed, and no impact on credit score. However, 401(k) loans must be repaid even for those in bankruptcy. |
| Partner/spouse consent | May be needed |
What are the impacts of a 401(k) withdrawal?
Unlike a 401(k) loan, a withdrawal is permanent and there are penalties and taxes no matter how much you take out.
| Time it takes to receive the withdrawal | Varies, typically around a week or two |
|---|---|
| Total withdrawal allowed | Vested account balance |
| Retirement savings growth | Will lose both balance and potential growth from decreased savings |
| Credit score | No affect |
| Partner/spouse consent | Depends; may be needed if the account balance is greater than $5,000 |
How does a 401(k) loan differ from a 401(k) withdrawal?
Let’s review an example so you can see how the two options differ. Suppose that Jo has a $30,000 medical expense and no emergency savings. She is age 40, at an effective federal income tax rate of 24%, and has $100,000 in a retirement account. Here’s how a 401(k) loan and 401(k) withdrawal would compare.
| Take money out path | 401(k) vested starting balance | Financial need | Taxes and penalties | Total loan or withdrawal | Remaining 401(k) balance |
|---|---|---|---|---|---|
| 401(k) loan | $100,000 | $30,000 | $0 | $30,000 | $70,000; $30,000 plus interest to be replaced in 5 years |
| 401(k) early withdrawal | $100,000 | $30,000 | $3,000 (10% penalty) + $7,200 (taxes) | $19,800 | $70,000; no replacement funds |
Notice the shortfall in a 401(k) withdrawal: The total is $10,200 less than the bill Jo intended to pay.
What is a hardship withdrawal?
A hardship withdrawal is slightly different than a typical early withdrawal, with its own set of implications.
The as “an immediate and heavy financial need” and limits it to just the amount necessary to meet that need. (Examples of hardship withdrawals may include medical and funeral expenses.) However, your plan is not required to provide hardship withdrawals, and your employer determines what those hardship circumstances are. In addition, you must not have other assets available that could cover the need, and you will have to provide proof. Like a traditional withdrawal, a hardship withdrawal is a permanent reduction in your retirement savings. While there are no penalties, as with an early 401(k) withdrawal, you will pay income taxes on the distribution.
What are emergency withdrawals?
Emergency withdrawals are relatively new—they were enacted as part of the SECURE Act 2.0 of 2022—and are another way to take money out of a 401(k). They too, have specific conditions and limitations. Not every 401(k) plan includes an emergency withdrawal option. For those that do:
| Amount allowed as emergency withdrawal | $1,000 |
|---|---|
| Uses | Unforeseeable or immediate financial needs relating to personal or family emergency expenses; typically you are allowed to self-certify the need |
| Payback required | No |
| Number of emergency withdrawals allowed | 1 per year, then none for 3 years after that unless the funds are paid back within 3 years; then the withdrawal is treated as a loan |
| Taxes and penalties | No penalties, but yes taxes, both federal and state, if required |
Can I take money out as a loan from my IRA?
No, traditional individual retirement accounts, or IRAs, do not allow loans.
How should I decide if I need to take a 401(k) loan or withdrawal?
Ultimately, it’s up to you and your financial needs and resources. If it is urgent, unexpected, necessary, and you have no other sources, it may be an option to consider. The best you can do is to understand the impacts and, eventually, think about how to rebuild your savings.
What’s next?
One way to build up your retirement savings without taking more from your paycheck is to save enough to get the full employer match, if it’s offered. How much are you putting away each month? to find out.
