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Why You Should Never Withdraw From Your 401k To Pay Off Creditors

Why You Should Never Withdraw From Your 401k To Pay Off Creditors

You may be in a world of debt that you simply cannot get out of, but do not believe what your creditors and other people say, the only entity that is able to seize money from your 401k is the IRS. You may be in a dark hole full of debt, but your creditors are not able to dip into your 401k or seize it in any way, and you shouldn’t use the money to pay them off either. Your 401k is your safety net and your fluffy pillow. It is the thing that is going to pull you out of debt and poverty when you retire (if you are still in debt…which is unlikely).

Take Money From Your 401K And You Are Giving Money Away

Money in a bundle that should stay in your 401k

Remove any money from your 401K before you are 60 (the current withdrawal age that is subject to change in the future), and all the money you remove is subject to tax. This means that all the money you remove is like fresh income and will be taxed as such. In addition, you will have to pay a 10% fee on the money you take out. Don’t forget that you also make hidden losses when you withdraw your money early, such as losing the interest and dividends that your money would have made if it had stayed invested.

Removing Money That Is Very Difficult To Replace

If you are having cash flow problems now, then it is unlikely that the lump sum you remove from your 401k will be replaced any time soon. You are very unlikely to add a lump sum back into your account, and the longer you wait, the harder it is to replace the amount you removed.

1000 Dollar bill

Instead of blinding you with math, think of it this way, if you withdraw $1000 when you are 30 and you retire at 65, you will miss out on $10,000. If you had left the $1000 in your 401k at the age of 30, you would have $10,000 extra in your 401k when you retire at the age of 65yrs old. That is assuming you only earn $30,000 per year and that your marginal tax bracket is 25%.

Under the same circumstances, if you were to have removed $16,000 rather than just $1000, you may lose as much as $160,000 from your 401k. A lot of money can be made and earned in just 35 years, and the loss from your retirement fund is staggering for the sake of just $16,000, which you can blow through in weeks if you are careless.

10000 dollar bill

Don’t Believe The Hardship Hype

Some people are going to tell you that you may get a hardship withdrawal from your 401k and “maybe” avoid some of the nastier fees for early withdrawal. It is not for me to say if you should do it, but the cost of your withdrawal is often more expensive than you may realize. Hardship withdrawals allow you to pull money from your 401k, but you still have to pay fees and penalties. Here are the reasons the federal government says you may use if you wish to withdraw money from your 401k.

  • Un-reimbursed medical expenses for you
  • Un-reimbursed medical expenses for your spouse
  • Un-reimbursed medical expenses for your dependants
  • Purchase of a principal residence
  • Payment for college fees for 12 months related to educational costs
  • Money to halt or prevent an eviction from your current residence
  • Money to halt or prevent foreclosure on your mortgage
  • Cash needed for funeral expenses
  • Cash for the repair of damage to your home

You are likely to incur the usual 10% fee if you withdraw money for any of the reasons noted above. You may be able to avoid paying the 10% fee if you fall into any of the categories listed below.

  • The court orders you to pay child support or dependency support that you cannot afford
  • The court orders you to pay money to your divorced spouse that you cannot afford
  • You are older than 55yr old and you take early retirement
  • You are older than 55yrs old and you are terminated
  • If you are deemed totally disabled, you may avoid the fees
  • Your medical debts exceed 7.5% of your adjusted gross income

Can You Take Out Money For Anything

Man cashes out his 401k to have fun

If you fancy a cruise, or if you are in debt, or if you want to get married, you may consider cashing out your 401k. Is it possible, are you able to cash out your 401k for any reason? Are you able to cash it out for “whatever” reason you wish? Short answer–no, long answer–yes.

No, You Cannot Draw It Out For Anything

No, you cannot. There are tough federal rules that stop people from withdrawing their 401k cash to spend on whatever they like. For example, if you want to take out a hardship withdrawal, you may have to prove to your employer that you have a genuine financial need that qualifies for an early withdrawal. If you do this, then you are able to start re-contributing to your 401k the next time you are paid. However, this method is rarely used because people are not keen to show how much financial trouble they are in to their bosses and co-workers.

No, You Cannot, But It Is Easier Than You Think

Instead of proving to your boss that you have financial trouble, you may self certify yourself. This is where you contact the people in your employer’s administration and arrange a withdrawal through your self-certification, which means you have declared that you need the money and want to withdraw it (the process is easier than I am making it sound).

If you self certify and arrange to withdraw your money, then you are banned from contributing to your 401k for six months. Some people think this is no big deal, but the money you contribute in half a year will add up to a tidy sum when you retire.

Yes, You Can If You Are Sneaky

You can self certify, which means you call up your employer and contact the department dealing with your 401k. You self certify and withdraw however much money you need.

You are only supposed to withdraw if you qualify for hardship. In the earlier sections, you saw a list of reasons why you may withdraw your money.

You should only self certify if you qualify for one of those reasons, but self-certifying means that you make the decision. In other words, you could be withdrawing because your mortgage is about to be foreclosed, or you could say that your mortgage is about to be foreclosed, and instead spend the money on a new car.

Conclusion – Getting Political On You

The less the government interferes in your life, then the more personal responsibility you have to take. That is the way a country should be run, and that is the way that the USA has ran for decades upon decades until the later years of the Bill Clinton administration when…let’s say the bar was dropped a little and things started going a little sideways. In my opinion alone, Mr. Ashley Gaynor, (Pen Name – Ash The Great), I think he should have shown a little more self control while in charge of the most powerful country on earth. Personally, I thought he was doing a good job up until he started doing what he did.

Bill Clinton Funny Speech

The federal government has no right to tell you what to do with your retirement money, but you have to admit that they have a point when they came up with the hardship rules.

If you are suffering hardship such as the types mentioned in the bullet pointed lists from earlier, then maybe you should consider withdrawing from your 401k. If you are not having financial difficulties such as those, then you really shouldn’t withdraw the money.

The federal government’s rules are very bendable if you are prepared to lie, but maybe you should stick to their rules (aka take their advice). If you are in debt, then you may go insolvent or bankrupt and your 401k is safe so long as it is in the right place (check before you file). You may be debt free by the time you retire and start enjoying your money, so why bother taking the money out now to pay off your debt? Just leave it in there and enjoy all the money it brings when you retire.

About The Author

Ash The Great

After a varied career in different industries from the hospitality industry to the financial consultancy industry, Ash now spends his days working as a professional writer.

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