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The Norwoods are a married, millennial couple, here to help you build wealth, so you can live the life you've always dreamed of. Brandon is an award winning licensed financial planner, and owner of Oak City Financial, with over a decade of experience and millions of dollars managed for his clients all over the United States.
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The Sugar Daddy Podcast
55: Should I Pull From My 401K To Cover An Emergency?
Watch this episode in video form on YouTube: https://www.youtube.com/channel/UCP55O4Ku4dukHcK0kExhpcA
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Now, also, the one thing that's taken to mind is that not all 401k plans are the same and not all the rules are the same. So when I hear somebody say they want to just withdraw money from a 401k plan when you're actively an employee, you might not even have the option just to withdraw money. Now, when you do withdraw money from a 401k plan prior to being 59 and a half years old, more than likely you are going to be assessed a 10% penalty for early withdrawal, so you do need to take into account.
Speaker 1:So that's right off the bat, that's right off the bat and if you have pre-tax contributions then you are going to pay taxes also in the amount that you withdraw. Hey babe, what are we talking about today?
Speaker 2:Well, we got a great question in our DMs about pulling out money from your retirement to cover an emergency, and so I'm going to read this message to you and then I need you to answer it, because I bet that there are several people who have thought, hey, I need to cover this emergency. I wasn't prepared. Or maybe an opportunity has come along, like hey, there's this house and I need a down payment, but I wasn't where I needed to be for my down payment, like, can I pull out of my 401k or 403b? So I think it is relevant because, I mean, I know, even I've had that question of like what if I needed to dip into this? But most of us have heard, no, you never want to pull from your retirement. So let me read this question and I definitely want your expertise on this.
Speaker 1:Okay.
Speaker 2:So I have a family member who had an emergency and was telling me that she wanted to withdraw from her 401k for this emergency. I told her she should never do that. My reasoning not to is that it will negatively impact her tax return and she will need to put it back in the 401k on top of fees accrued. So my question is what are your thoughts on withdrawing from a 401k? How can this impact your tax return? What types of fees are involved? What other options do you recommend for an emergency that will give access to funds within a few days or a week? And example, like a line of credit on your home, possibly? What do you think? I don't know. I was just always told never to dip into your 401k. Thanks so much.
Speaker 1:No, I think that's a really good question. I think it's one that probably has crossed a lot of people's minds.
Speaker 2:Right.
Speaker 1:So let's start with. You know the adage that you always hear don't ever withdraw from a 401k plan. Obviously, that's not the ideal scenario. Main reason being is that the power of compound interest so having put money in there year after year after year, and then the interest gaining interest on top of interest is one of the biggest pluses you can have from an investing standpoint, just in general, all right. So if you don't have to dip into that, because the idea for these accounts is that it is for retirement, when you do get of retirement age, obviously you don't want to take money from there if you don't have to.
Speaker 2:Right, because our younger selves are taking care of our older selves.
Speaker 1:Exactly.
Speaker 2:By investing in our retirement accounts.
Speaker 1:But the reality is that things happen, you know.
Speaker 2:Life be life.
Speaker 1:Life happens and sometimes you don't have any other options. So in the scenario where there are no other options, I am not going to shame someone, for you know having to do that. That's not how I operate. Also, it doesn't do any good to shame someone about that. But the biggest thing is a shame-free environment, that, but the biggest thing is a shame free environment, yeah, but the biggest thing is that it all depends First of all, what is the emergency?
Speaker 2:That's the key that I thought was missing, Like what is the emergency and what was the amount? Are we talking? I need five thousand dollars, twenty thousand dollars, one hundred thousand dollars. We don't know at this point.
Speaker 1:So I think what is the specific emergency makes a big difference, because I think sometimes not that I am the person who is to define all emergencies for each individual, but let's be honest, some people say an emergency and it's really not an emergency.
Speaker 2:Those cute boots at the store that went on sale.
Speaker 1:So is this an emergency, where this is a dire situation, all right. So in this scenario, we're just going to assume that it is All right, right. First thing is, when people say that I have to dim to my 401k plan, I do a little pushback and is there any other place that you could get money from, whether that be, you know, some other type of I'm assuming in the scenario you don't have an emergency fund, or even if you do, because you're a little bit of money in there, something or another, so you don't have to pull out quite as much. All right, so let's look at some other options. Do you have family members, you know? Could you possibly, you know, borrow some money from your parents, or whatever it may be? Look at all the possible options that may be available to you now, you know.
Speaker 2:so sometimes you might not have any other that the money, she would need, the money within a couple of days or a week. So again, some of the processes where, like, maybe you take out a home equity line of credit, like a HELOC. Yeah, that's not going to be a quick process, that's not going to be a quick process, so I think time is of the essence here. So again, we don't know what the actual emergency is, but that is one of the caveats there.
Speaker 1:Yeah, so that makes a difference also because you know if you do own a home and you do have equity in your home. These are, you know, scenarios you could weigh out. You know, obviously with the home equity line of credit there is interest involved, Same with the home equity loan. You know you do have sometimes the options of a cash out refinance. Obviously that wouldn't be the best scenario, probably now because interest rates are high. But looking at all options that you have first and seeing, you know maybe which one makes a little bit more sense, maybe a little bit easier to get the money maybe less of a detriment in the longterm of doing you know the specific route.
Speaker 1:Now, also, the one thing that's taken to mind is that not all 401k plans are the same and not all the all the rules are the same. So when I hear somebody say they want to just withdraw money from a 401k plan, when you're actively an employee, you might not even have the option just to withdraw money. Now, when you do withdraw money from a 401k plan prior to being 59 and a half years old, more than likely you are going to be assessed a 10% penalty for early withdrawal. So you do need to take into account.
Speaker 2:So that's right off the bat.
Speaker 1:That's right off the bat. And if you have pre-tax contributions, then you are going to pay taxes also on the amount that you withdraw, and what is going to be taxed is ordinary income tax. So let's just say, hypothetically you needed to withdraw $10,000 and you were able to do that. You're going to pay taxes on that $10,000. And it's just going to be as if you made an additional $10,000 for that year and then, in addition to that, you would have a 10% penalty on top of that.
Speaker 2:So also then, do you have to consider the 10,000 or, excuse me, the 10% penalty into the amount that you're taking out, because you need to then cover that amount that's being taken. Like if I needed $10,000, but I'm being taxed 10%, then I actually need to be taking out more than $10,000 to make up for that added percentage.
Speaker 1:It could possibly depend. So most of the time they are going to withhold 20% for the taxes Now, whether or not you have to withhold the additional 10% penalty. Sometimes you have the option of going ahead and doing that now, or you have the ability to just not do it at that point in time and you're going to have to do it when you file your taxes.
Speaker 2:So how do you know which-.
Speaker 1:It'll show you the process, whether it's done online or online through your portal that you have, for whoever your provider is, or if you're calling in to process this, then they would be able to, you know, walk you through those steps.
Speaker 2:Like, and they would just say you don't have the ability.
Speaker 1:Ideally, and I say ideally because I, as someone who, early on to start out their finance career, has worked in a call center for 401k plans, where you know you call in to get information about your 401k plan or do whatever you were talking to me I could tell you that there is a wide variance and the level of knowledge of those individuals who are doing the job. As someone who I think you know I was on the better end of doing that job, I definitely worked next to people who should not have been doing that job.
Speaker 2:Which you know what's funny and I'm going to call this out because one of the things that we often do and you do it as well is, if you want to verify certain information with certain you know entities right, like if you're calling into Fidelity or wherever your plan might be once you have your answer, hang up and call again, because you're going to get another person and they might tell you something very different, and then you're going to be like, oh crap, what do I do? I need to do a little bit more research, versus just taking 100% of what somebody tells you again, like at a call center, and them saying, yes, this is what it is, and then you trusted them and they kind of screw you over.
Speaker 1:And, like I said, you can get someone in a call center that is extremely knowledgeable, but often the first person you're talking to is not a licensed advisor at all. There's simply someone who was hired for the job and they have some knowledge base in 401k plans and maybe how that specific plan works, but they are not an advisor. That is not the first person you're talking to. Now. You could be passed along further along, depending on what your question, to a licensed advisor, but the first person you're talking to at the call center is not a licensed advisor. I can guarantee you that.
Speaker 2:Have you been listening to our podcast and wondering how am I really doing with my money? Am I doing the right things with my investments? Am I on track to reach my financial goals? What could I be doing better? If you answered yes to any of these questions, then it's time for you to reach out to Brandon to schedule your free yes, I said free 30-minute introduction conversation to see how his services could help make you the more confident moneymaker we know you could be. What are you waiting for? It's literally free and at the very least, you'll walk away feeling more empowered and confident about your financial future. Link is in our show notes. Go, schedule your call today. So the first thing you need to find out is can I even withdraw from my 401k?
Speaker 1:Correct. So you need to find out the details of your specific 401k plan. Now, sometimes some 401k plans do allow you to have what's called a hardship withdrawal. What it allows you to do is withdraw money from your 401k plan If you qualify for certain types of hardship, you know. One of the big ones I could think of is like medical expenses or, if you're about to, you know, before closing your home, stuff of that nature. So not every reason qualifies and, depending on the reasoning, you might have to actually provide supporting documentation to show that this is a valid reason. So you just can't necessarily call in and make up a reason.
Speaker 2:So again, this might not fall in the category of I need money in the next few days, correct, or a week, correct, okay.
Speaker 1:Now, the one thing that I do implore people to do is that, instead of looking for just simply to withdraw money, is to possibly see if you have the ability to do a 401k plan loan.
Speaker 2:What does that mean?
Speaker 1:So it's just simply taking a loan from your 401k plan and paying it back.
Speaker 2:Through your paycheck, correct? And what are those limitations or stipulations?
Speaker 1:So, the limitations for most plans is going to be that you have access to either 50% of your vested balance or up to $50,000, whichever is less 50% of your vested balance or $50,000, whichever is less yes.
Speaker 1:So, for example, let's just say because let's just say, like you have a total of $50,000, whichever is less yes. So, for example, let's just say because let's just say, like you have a total of $50,000 in the account, even if you have $50,000 in the account, you only have access to 50% of that, if it's best in balance, because you don't, like I said, it's either 50% or $50,000, the lesser of the two.
Speaker 2:And I can just take it in one lump sum.
Speaker 1:You can, so you have to look at your plan, all right. So, like I said, some plans I would say on average, most plans maybe allow you to have two loans at a time, so you have to take that into account as well.
Speaker 2:Two loans from the same 401k plan, correct, oh, interesting. So like if something happens now and then something happens later.
Speaker 1:Correct and if you still have money available. Because if you max out yeah, if you max out the amount that you can get on the first loan, then you don't have the second loan available because you don't have any money that you could take.
Speaker 2:And then when you pay back your first loan then you would have access.
Speaker 1:Then that clears that loan off. Now sometimes there might be a waiting period so you might pay off a loan and you might have 30 day waiting period before you can actually get a, before that loan is, quote unquote, wiped off of you know your record even though you paid it back.
Speaker 2:Interesting.
Speaker 1:And it's also like with with the 401k plan loans. Most of the time you can have up to five years max that you can pay it back. So basically, payments are taken out of your paycheck every pay period and the maximum time frame you could do that is five years. So that would lower the amount that each payment is that's coming out of your paycheck and you also have most plans allow you to also pay it back in a lump sum early.
Speaker 1:But I always tell people to make sure you have all the details before you take the loan out, because I look at someone's plan and if they have the availability to do a five-year max and they could pay it back early, I often choose the five years max, even if they don't need it, because it gives them flexibility so that they have the five years if needed, because if something else comes up and they don't want to be stretched thin in regards to the payments, they have that five-year period with the lower payment. But if they are collecting money on the side and building up a savings, then they can always pay that loan off early if they have that option. But I always make sure that that option is available to them first, because some of these plans don't allow you to pay loans off early. It's all about finding the specific details of your 401k plan.
Speaker 2:Okay, so I just want to be clear. You would take a loan from yourself, because this is your retirement account, your 401k, and then coming out of your paycheck would be the payment back to yourself, correct?
Speaker 1:To your account. So it's based upon the amount that you pull out. But then there also is an interest rate attached.
Speaker 2:I was going to say I can't imagine. This is free.
Speaker 1:Well, it is free.
Speaker 2:Well, because it's yours. But what's the interest? The?
Speaker 1:interest rate is going back to you. The interest rate is based upon the current interest rate environment. But that interest is paid back to you. It's not paid to the company.
Speaker 2:And then how do you, once you put in like I want to pay this back in five years, that automatically will deliver a payment for your paychecks.
Speaker 1:So most of the time, what you can do is that you can basically model what the loan would look like. So if you go into your online portal for your provider of your 401k plan and you're like I want to take out a loan, it would show you on the online portal one if you have one available to you. So let's just say you have one available to you, you select the amount. It'll show you the amount that you have eligible for and then you can choose the amount that you need. And then you also choose the time period in regards to paying it back, and if you choose five years, it'll show you what each payment would be coming out of your paycheck prior to submitting it and actually taking the loan itself.
Speaker 2:Now you've taken the loan, you're paying yourself back every paycheck. Are you still also contributing to Depends? Okay, everything always depends. Well, it does, because every plan is it's your favorite thing.
Speaker 1:Well, the thing is, every plan is different and it's based upon what the employer is willing to pay for. So if you have a very robust 401k plan where you have a lot of options of what you can invest in you have all of these bells and whistles to it your employer is paying more for that plan than the other person who has like five things they can invest in and has just the bare bones. That plan costs less money to the company then. So it all depends on what your company is willing to invest in the plan for its employees.
Speaker 2:So let's say you have a quote unquote good plan. Is it likely that you could be paying your loan back while still also putting contributions in and getting that company match, if you have?
Speaker 1:one, for example. That is a possibility.
Speaker 2:So then is there. If that was the scenario we're talking about, is there a downside to taking that loan?
Speaker 1:Except for that, the amount is not compounding. Well, yes.
Speaker 2:That's the downside, yeah.
Speaker 1:So the money that you had taken out is no longer in the account to grow. So if you had you know, let's say you did the max you took out $50,000. That's $50,000 that is no longer in your account to grow.
Speaker 2:Right, okay. What else do we need to know about taking out money from our retirement accounts to pay for things?
Speaker 1:I mean, honestly, that's the biggest thing pay for things. I mean, honestly, that's the biggest thing. So the one other thing that I also try to tell people to think about, too, is that this is the one thing I think is the biggest thing that's overlooked. When taking out a 401k plan, loan In this environment, with you know, our generation, how long are you going to be at that employer?
Speaker 2:Oh, talk about that.
Speaker 1:Because people, nowadays you switch jobs. You know fairly quickly it's not like, oh, I'm going to be at this job for 15, 20 years. You might be at the job for a year or two before a better opportunity comes along and you switch employers. Now with a 401k plan loan, what ends up happening is that if you have a loan out and your employment is terminated whether that's you switching jobs or you being laid off or fired, whatever it may be- you then have to pay the loan back in.
Speaker 1:You then have to pay the loan back Exactly In full. You have to pay the loan back in full.
Speaker 1:So if you took out $50,000, and you've paid back 10 and you have still a $40,000 balance outstanding and you switch jobs. You are now on the hook for the $40,000. Now you don't have to pay it back, because then what ends up happening is that if you don't pay it back, you aren't able to. Then you now have done a $40,000 withdrawal and now you're looking at paying the taxes on the $40,000 withdrawal and also potentially that 10% penalty.
Speaker 2:Okay, so when in the message she was talking about the tax implications, those are some of those items to think about, because it's essentially income that is going to be taxed.
Speaker 1:So basically, if you left your employment in the middle of an outstanding loan balancing your 401k plan and you were not able to pay it back, you have now essentially turned that loan into a withdrawal.
Speaker 2:Hmm, is there anything that the company could then do to kind of come after you for the fact that they?
Speaker 1:It's the IRS. It has nothing to do with the company, it's your money.
Speaker 2:Okay.
Speaker 1:It's the IRS that's doing all this. The company's not doing this. The company's not asking for you to pay them back, okay. No, it's an IRS guideline in the sense of now I've seen that you've taken $40,000 out that you have not paid back in, so you owe the IRS for the taxes and the potentially the 10% penalty.
Speaker 2:And we know how lovely it is to do anything with the IRS.
Speaker 1:Yeah, this has nothing to do with the company.
Speaker 2:Okay, wow, all right. Well, are we missing anything?
Speaker 1:Is there anything else you want to share? I mean, that's I would say that's the high.
Speaker 1:I wouldn't even say high level, because we got, honestly, deeper into the weeds. But that is the basis of what you would need to think about. The biggest thing, and which is why I take it, even, you know, kind of a step further back, is that. That's why it's so important to focus on having that emergency savings. You know a lot of people unfortunately at the sacrifice of investing. They, I mean at the sacrifice of savings they invest instead. Now. Investing is extremely important and you should be doing it, but not at the sacrifice of saving money for something that's going to happen tomorrow, Because, as we've talked about before, investing is a long-term play. So 10, 20, 30 years into the future that's what you're looking at when you're investing, and if you can't make it through an emergency tomorrow, investing 20 years into the future is not going to be beneficial to you Right, and we know there's really always something right.
Speaker 2:There's a broken appliance, there's something with the car. I mean what? Just last week you had another car thing right.
Speaker 2:Which cost us $547. I mean it literally. There is always something that you need to be prepared for, but if you have an emergency fund, use it. I think a lot of people once there is an emergency, a true emergency not you know, the purse that you've been eyeing is on sale but a true emergency people then have a hard time using that money for said emergency and like that's literally what you've been saving it for. So don't feel bad using it, because that's what it's for.
Speaker 1:And also, too, like you know we, how much money do you need for this emergency? So we're just assuming that it really is an emergency. How much money do you need? Because if you don't even have enough money in your 401k plan to access that you can access for this emergency, it doesn't even make sense to pull the money from there. So, for example, say you need 50,000, but all you have is 20,000 and it's throwing $20,000 out of your 401k plan and paying the penalties and taxes on that. Is that going to help you at all when you still have $30,000 that you need there? So that's also taking a step back and looking at the entire situation and what is best way to deal with that situation. Because we do have an episode coming up where we spoke with a bankruptcy attorney and it really changed our mindset around sometimes filing bankruptcy in certain scenarios.
Speaker 2:Yeah, that's going to be an incredible episode. We're so excited to share that. I think the overarching, and we'll just give you a little teaser of the episode. When we asked what is one thing that people need to know about debt and bankruptcy and when to explore it, she said if you cannot pay off your debt without accumulating more debt in three years or less, you should be speaking to a bankruptcy attorney. In three years or less, you should be speaking to a bankruptcy attorney. And that was, I think, for both of us honestly was really eye-opening. If you cannot pay off your debt, all of your debts in full, the non, what did she call it? She was such a lawyer.
Speaker 1:The non You'll have to tune in.
Speaker 2:Yeah you'll have to tune in for the specific lawyer talk, because we are not attorneys, but it's the credit card debt, the car loans, the I mean all of like the consumer type debt that you can wipe out in the personal bankruptcies that we talk about in this episode. If you cannot pay off those debts in three years or less without adding any additional debt, she recommends working with and talking to a bankruptcy attorney. So that episode is coming out. Hopefully at least this answered some questions about pulling from your retirement accounts for your 401k and using that as a potential safeguard for an emergency. But if you have any other questions that are in this realm or like this or you're going through anything that we can answer for you, you can always slide in our DMs, hit us up on email, on Instagram, you can leave us a voicemail. All of those notes are always in our show notes, but we'd love to hear from you and hopefully this episode was helpful. Don't forget Benjamin Franklin said an investment in knowledge pays the best interest. You just got paid. Until next time.
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