If you ever need to get money out of your 401k retirement plan early there are two ways you can do it. You can either take money out of your plan by taking a withdrawal or you can take a loan out of your account. Each way is better for different situations.
If you choose to take an early 401k withdrawal you may be forced to pay a 10% penalty for the money you take out in addition you will have to pay taxes on that money.
The good news is that you will get cash now, which can be very helpful during certain times in our lives. The bad news is that a good percentage of that cash will be off to pay taxes and penalties. Once more any cash that you take out of your 401k will not be able to make more money for you like they would if they were in a 401k.
In other words taking out $20,000 now could mean that you will have $80,000 less when you retire because of the interest you would be earning off that money. Obviously that is something that would be better if it could be avoided
Another way you could take money out of your 401k is by taking out a loan. This is simply a loan you are borrowing from your retirement plan which you will have to pay back with interest.
These loans are very popular because no one needs to check your credit history and you will not need to worry about not being approved. a 401K loan will also normally have a much smaller interest rate then banks will give you.
But be warned these come with a few 401k loan rules which can make taking a loan very painful to your financial future. The greatest disadvantage is that you may not be able to deposit more money into your account or the amount you can deposit will be greatly reduced, until the loan is repaid.
This could seriously hurt in the long term, especially if it is going to take you the full 5 years to pay it back. For instance let’s say you are depositing $10,000 a year into your 401k. If you take out a loan for 5 years that means that you will not be able to deposit money for 5 years. That would be $50,000 that you would would miss out on, and that is not including the interest you would have made on that money.
So, which is better? Hopefully you will never have to make this decision but it depends, based on a number of factors such as how long it will take you to payback a loan and if you can afford to take out another loan.
If it will take you 5 years to repay the loan and the added expenses will really affect you, you might be better off by simply making a withdrawal.
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