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Typically you need to keep the money in the plan until you reach age 59 ½. Withdraw any of it before then and you’ll be hit with a bruising 10% early withdrawal penalty, on top of the regular income tax that is due on withdrawals. Bad idea.
There are exceptions, however. The IRS waives the 10% penalty for certain “hardship” withdrawals. Each plan’s rules vary (check yours to be sure), but you may be able take money out of your retirement account penalty-free before age 59 ½ if you use it for:
- Purchasing your first home
- Expenses after the onset of a sudden disability
- Higher education expenses (like college for your kids)
- Payments you make to prevent eviction or foreclosure.
You should consider all these last ditch options, though. After all, the money is locked up until retirement for a very good reason: If you spend it now, you risk jeopardizing your financial security when you’re older.
If you can’t get the money anywhere else, your best option is probably a loan. Many 401(k) plans allow you to borrow against the amount in your account. You must repay the money to your account within a set period – usually a few years – or the loan is treated as a withdrawal, meaning you’ll owe taxes and a 10% penalty on it.
There are three main drawbacks to taking out a loan. First, you reduce the money you have growing for your retirement years. Second, you have to pay interest on the amount you borrow — typically the prime rate plus one percentage point — though you do pay the interest to yourself. Third, you must repay any outstanding loan within a few months if you are laid off or decide to change jobs.