Think Carefully before You Treat Your 401K like An ATM

If money is tight and you are thinking about tapping into your retirement funds as a possible solution, financial advisors warn that you need to grasp the ramifications of tapping your retirement dollars before you are supposed to. Just because this process is relatively easy to do, it doesn't mean it is always the right decision to make. According to research, about 33% of 401K investors tap into the cash in their accounts prior to age 59 and a half. At age 59 and a half most withdrawals can be made without facing a 10% early distribution penalty and income taxes. That same research identified that 21% of 401K investors currently had outstanding loans against their accounts in 2012.

The average unpaid balance of those was over $7000. Even though 401K plans were created and designed to allow workers to put away pre-tax money for their retirement, these accounts have become an immediate emergency fund for many Americans. If you are going to do this, it is imperative that you understand all of the potential aspects of moving forward with a loan against your 401K. If you are financially desperate for funds this can enticing if your company's plan does allow it. You may be banned from making new contributions to you 401K for 6 months depending on the plan's rules. You also won't benefit from pre-tax contributions that lower your gross income and help to limit what you owe at tax time. Loan payments are made with after-tax dollars.

This is unlike 401K contributions. The loan payments can last up to 5 years and are yet another expense that you'll need to factor into your budget. If you lose your job, however, the loan balance on the 401K can become due immediately and if you are unable to pay it, it can become an early 401K distribution and is subject to a 10% penalty along with incomes taxes. Taking loan against your 401K or other retirements plans can prove problematic if you end up getting a divorce and the full value of the account has to be calculated for the purposes of dividing it between the original plan participant and the alternate payee. Make sure that if you're entering into a qualified domestic relations order you have an expert on hand to help you. A QDRO expert makes it easier to identify challenges before they become the cause of your QDRO being rejected.