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Asked 2/4/2009

Withdrawling money out of my 401k plan

What is the penalty for withdrawling money out of my 401k plan to pay off credit cards?

 
 
 
 
 
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Answer 1/1 - Submitted 6/4/2010

Simple answer - probably more than the interest rates on your credit cards!

Assuming that all of the Contributions to your 401(k) were pre-tax, you will pay the highest marginal Tax rate on your Tax Return for the entire Distribution. You will have to talk to your Tax Advisor now (not during Tax Season) to get that most probable percentage.

Your company's Plan Sponsor will "help" (yes, I am being a little sarcastic by using the quotes) you on the Tax side by automatically deducting 20% and giving it to the Federal government before writing a check for what's left over to you.

If you are under 59 1/2 when you take the Distribution, you will also get hit with a 10% penalty for a Premature Distribution. I should also mention that there may or may not be a state and/or local Tax bite to worry about when you get your check and/or file your Tax Return.

An alternative to taking a Distribution (and accepting all of those Taxes/penalties) is to take a Loan from your 401(k) - if your Plan allows. Though I am not a fan of 401(k) Loans, it may be better than a Distribution.

Whether you take a Distribution or a Loan, you are still missing out on growth in your account as we crawl out of this 'Great Recession.' If you had taken money out shortly after you posted this question, you likely have already missed the 6-month 'correction' that saw the stock market pick up nearly half of the losses incurred from the stock market's peak just a couple years earlier.

Add the lost opportunity (and I expect more increases in the stock market since we are STILL not out of this recession) to the Taxes and Penalty, then compare it to your Credit Card rates. Hopefully, this may spur you to look elsewhere for funds (cutting down on spending, searching for unclaimed funds long ago turned over to the states, downsizing your lifestyle, adding side jobs for increased income, etc.) rather than at your 401(k) Plan.

On the other hand, you may have already tried these other paths and found them lacking. In which case, I wish you luck and good speed in continuing to seek out advice from all corners in this economy!

P.S.: Just to clarify, I don't expect credit cards will be as generous as they used to be with interest rates any time soon; nevertheless, there are still bargains out there if you are persistent (even in the credit market).

 
 
 
 
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