What’s A 401 (k) Loan or Hardship Withdrawal? What You Need To Know

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Sometimes life hurls a difficult, unexpected (and costly) event your way, and you find yourself wondering how you’re going to pay for it. Hopefully you’d be able to rely on any money you set aside in an emergency fund to pay for your expenses, but if you do not have enough there (or any at all), you may be looking for an alternative solution.

If you have a 401 (k) account through your employer, one option you may have available is taking out a 401 (k) hardship loan or using a 401 (k) hardship withdrawal to help fund some of those expenses.

However, it’s important to note that before turning to a 401 (k) loan, you should exhaust all your other options for extra money first. This means exploring any emergency money you may have set aside, dipping into any additional savings you have, or even seeing if it’s possible to take on a side hustle that will cover the cost of what you need to pay for. This is because when you borrow from your retirement account, you’re taking away the potential for that money to keep growing over time – especially if you withdraw your entire balance.

Here’s what else you need to know about taking out a 401 (k) loan or making a 401 (k) hardship withdrawal.

How 401 (k) loans work

A 401 (k) loan lets you borrow money from your workplace retirement account on the condition that you pay back the amount you borrow with interest. The good news is that the payment amounts and the interest go right back into your account.

The interest rate you pay on a 401 (k) loan can change over time. According to Debt.org, the interest rate you would pay on a 401 (k) loan is usually a point or two above the lending rate used by banks. The rates used by banks is called the prime rate and it’s influenced by the federal funds rate, so it can change over time. So if the prime rate is 5.2%, the interest rate you pay on your 401 (k) loan may be around 6.2% to 7.2%.

Because your 401 (k) is an employer-sponsored account, you’ll need to abide by your employer’s plan rules around taking out a 401 (k) loan. Many employers have limits for how much of your balance you’re allowed to borrow and how many loans you can take from your account per year – you’ll need to double check the guidelines around your employer’s plan before you take the next steps to borrow from your 401 (k).

Keep in mind that if you were to leave your job before repaying a 401 (k) loan in its entirety, you might have to repay the money you borrowed immediately (or at least over a much shorter period of time).

What about 401 (k) hardship withdrawals?

401 (k) loans are not to be confused with 401 (k) hardship withdrawals. A hardship withdrawal is not a loan and does not require you to pay back the amount you withdrew from your account. You’ll pay income taxes when making a hardship withdrawal and potentially the 10% early withdrawal fee if you withdraw before age 59½. However, the 10% penalty can be waived if you can provide evidence that the money is being used for a qualified hardship, like medical expenses or if you have a permanent disability.

Another key difference between the two is that with 401 (k) hardship withdrawals, you would be unable to pay yourself back what you took from your account. This is not the case with 401 (k) loans.

The qualifications for a 401 (k) hardship withdrawal depend on your plan and the rules of plan’s administrator, so make sure to check to see how you can qualify for one.

Alternatives for funding

Ally Bank Online Savings Account

Ally Bank is a FDIC Member.

  • Annual Percentage Yield (APY)

  • Minimum balance

  • Monthly fee

    No monthly maintenance fee

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle * The 6 / statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

  • Transfer fees

  • Offer checking account?

  • Offer ATM card?

    Yes, if have an Ally checking account

Marcus by Goldman Sachs High Yield Online Savings

Goldman Sachs Bank USA is a FDIC Member.

  • Annual Percentage Yield (APY)

  • Minimum balance

    None to open; $ 1 to earn interest

  • Monthly fee

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle * The 6 / statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

  • Transfer fees

  • Offer checking account?

  • Offer ATM card?

US Bank Visa® Platinum Card

On US Bank’s secure site

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% for the first 20 billing cycles on balance transfers and purchases

  • Regular APR

    15.24% – 25.24% (Variable)

  • Balance transfer fee

    Either 3% of the amount of each transfer or $ 5 minimum, whichever is greater

  • Foreign transaction fee

  • Credit needed

Wells Fargo Reflect℠ Card

On Wells Fargo’s secure site

  • Rewards

  • Welcome bonus

  • Annual fee

  • Intro APR

    0% intro APR for 18 months from account opening on purchases and qualifying balance transfers. Intro APR extension of up to 3 months with on-time minimum payments during the intro and extension periods; balance transfers made within 120 days qualify for the intro rate

  • Regular APR

    13.74% to 25.74% variable APR on purchases and balance transfers

  • Balance transfer fee

    Introductory fee of 3% ($ 5 minimum) for 120 days from account opening, then up to 5% ($ 5 minimum)

  • Foreign transaction fee

  • Credit needed

Editorial Note: Opinions, analyzes, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.

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