Dear Carrie: If you're younger than 59 1/2, is it possible to withdraw money from your 401(k) without having to pay it back? -- A Reader
Dear Reader: In difficult times, a 401(k) can seem like the answer to a variety of financial problems. The money is there, it's yours -- and why not use it to pay off debt or get out of some other financial jam? And yes, it's possible to take an early distribution from a 401(k) without having to pay it back, depending on your personal situation and your specific plan.
But to me, the issue isn't so much whether you can take money from your 401(k) before you reach age 59 1/2. The question is whether or not you should. First, consider that all distributions from a 401(k), no matter your age, are taxed as ordinary income in the year in which the money is received.
Plus, unless you meet specific criteria, early distributions are subject to an additional 10 percent penalty. Together, this could take a huge bite out of your distribution -- not to mention your future retirement savings.
So before you drain your retirement account, make sure you've considered all your alternatives, including a loan from your 401(k) account, as opposed to a distribution. At least with a loan, there are no taxes or penalties. And while you do have to pay it back with interest, that payment is going into your own account. However, if you feel an early distribution is your only option, here are some things to consider.
If your plan allows it, you can take a hardship distribution if you prove immediate and heavy financial need. The amount of the hardship distribution is limited to your own contributions to the plan and possibly your employer's contributions, but it doesn't include earnings or income on your savings. The terms of proof once again depends on your plan, but in general, the IRS defines immediate and heavy financial need as:
-- Medical expenses for you, your spouse or dependents.
-- Costs directly related to the purchase of your principal residence (excluding mortgage payments).
-- Post-secondary tuition and related educational fees, including room and board for you, your spouse or dependents.
-- Payments necessary to prevent you from being foreclosed on or evicted from your principal residence.
-- Funeral expenses.
-- Certain expenses relating to the repair of damage to your principal residence.
Regardless of why you need the money, you have to pay both income taxes and a penalty on a hardship distribution. Let's say you want to take $20,000 from your 401(k) and you're in the 25 percent tax bracket. That would mean you could owe $5,000 in income taxes on your distribution.