Cashing out a 401k. . . Never a good idea?

[Barefootinthewoods]

We're in a really tight spot right now, and DH keeps bringing up the "option" of cashing out his 401 k.

His reasons for it are

1. Quick money that we need NOW in order to ensure a better financial future 

2. His employer stopped matching contributions after one year and although he pays into it every paycheck, its not "making any money" and therefore "its not worth anything"

3. He wants us to save for retirement on our own because of the economy, govt, wall st, etc

4. He cant think of any other options.

I don't know a THING about retirement accounts other than the story passed around in our family ...... "Did ya hear about so and so cashing his retirement out to pay for his sons rehab and 6 mos later he's back on smack?  Now he has no retirement and he's still a junkie. Never ever, cash out your 401k!"

I don't know what to do.  I'm really stressed out and worried about money. About freezing or starving to death, being homeless. We have not been able to increase our income and any job leads in the last 2 year have always fizzled out due to requiring significant pay cuts. DH has decided that his best option is a complete career change, and is depending on being hired right out of school, making what he makes now, and perhaps, a few dollars more. According to our research and talking to others who have made the same career change in the last few years, SEEING their pay-stubs, this career has opportunities for advancement/more money, AND if we continued our frugal lifestyle, we could *potentially* pay off our house in 8 years rather than scrape by in our current situation, where our housing is 42% of our income and we choose groceries over paying the electric bill.

He's taking every last cent we have to pay for his training, but  this will leave us no money for oil, birthdays, holidays, winter clothes, winter car repairs, emergencies,  etc after he takes it all for this class. Financial aid is unavailable as it is a career training and not degree acquiring. No scholarships or grants available that we've found. This stash of $$  isn't something that can be replaced.  I suppose we could "replace" it with next yrs tax return. (We get an earned income credit and child tax credit) In the meantime his paycheck is only enough to cover basic necessities. housing, food, electric, a phone, and gas for the old falling apart car. That's it. We've already been living super frugally. We don't buy anything other than food and the occasional second hand clothes, we don't have cable, use paper products etc. All the "standard ways" to nip/tuck the budget have been in effect for YEARS.  If you think you have one I haven't heard or tried, bring it! I'm open to all ideas

If he starts a new career, making what he's making now, the knowledge that he will triple our income in 2-3 years wont keep us warm or clothed come December.  This is where the 401k idea tempts me. Its quick money, that i didn't know existed, in a sense, and I'm not sure there are other options.  I could get a job fairly easily in the medical field but I'd have to sacrifice our lifestyle(my studies/training, unschooling our kids, working towards sustainability on the homestead), and after childcare costs I'd only bring home $45 a week. I cant convince myself that $45 a week is worth it. Im still looking for other options.

So, what are we really in for? How does this 401k thing work...what do we need to know to make a wise decision? And suggestions or alternate advice?

[Caneel]

We did take money out of a 401k one time because of an emergency.  The quick version of I what I remember:

There is an automatic 10% penalty that is taken by the investment company

All Federal income taxes on the current value of the money will be due.  The actual amount will depend on your personal tax bracket but plan on 20% to 30%.

So you can plan on "losing" 30 to 40% of the balance of the account before you get your hands on the money.   Personally, I would avoid doing this if at all possible.   I would go back to work before taking out that money. 

We put a lot of money into our retirement accounts and never kept enough cash on hand as an emergency fund.  I know better now.  I would not recommend cashing in the 401K but I also know that sometimes the "wrong" decision is necessary when life throws you a curve.

[its_betty]

If your dh is still contributing to his 401k, he could stop that for now. It will put a few more dollars into his paycheck, and it sounds like you need that. (Although it won't be as much as you might expect, because the 401k is pre-tax dollars.) Then be sure to build retirement savings into your budget as soon as you can.

IMO, I'd avoid taking money out of the 401k if at all possible. Paying taxes and penalties on the money you take out will eat away 35-40% or more (as PP noted). That's painful. 'Future you' needs money, too, and the longer you can let investments and interest do their thing, the better. You and dh may want to research and review the investment choices that the 401k offers, to make sure your money is in the best-for-you options.

[APToddlerMama]

Well, in general, I wouldn't pull money out of a 401k because you do pay the penalty on top of your regular taxes.  But, in your case it doesn't sound like a bad idea.  a 401k is an investment in your future, but obviously this career training is an investment as well.  If this job allows your DP to make more money, you can replenish your 401k later.  Also, it seems silly to keep money in savings when you're saying you are worried you will starve, not have money for oil, etc.  I think there are times when it is an okay decision to make. 

ETA...My dad is financial planner and advised us in the past to pull our money out of our 401k if we had to in order to get out of a bad housing situation.  I know conventional wisdom is never to do it, but sometimes you need to take some risks to advance career wise and obviously you need to eat and heat your home. 

[ellairiesmom]

Is he still employed where he has the 401k?  Would he be working there still while training for the new career?  I ask because there are different options depending on his employers rules for the plan.

Having worked in the 401k industry for 12 years, yes, the rule of thumb is never, ever touch your 401k, you'll be responsible for a 20% fed tax, whatever your state tax is & then you will get hit with the10% early withdrawal penalty yada yada yada.  That is your "Hardship Withdrawal" category, you need to prove the hardship.

The other rule of thumb was that there were a few instances when it was the right decision...your kids college tuition, first time purchase of a home...

There are loans you can take when you are still actively employed that involve no taxes, no penalty. My rule of thumb was that if my credit card debt got too crazy (happened in my 20's twice while working there-took twice to learn my darn lesson!) it was worth taking the loan out, paying off the high interest debt & then paying myself back with the interest.  You don't lose any taxes or penalty in that scenario & as long as you are working there & having the repayments coming out of your paycheck back into your 401k.  You can even turn off your contributions while you are paying back the loan so that only the loan repay is coming out of your check which helps offset the change in your paycheck.  If you leave before you pay back the amt you borrowed from yourself, it becomes a taxable distribution for that tax year.  

The idea of retirement/401k savings is nice, but when you need to improve your situation, you gotta do what you gotta do sometimes.  We are using mine to make a major housing change in our lives as well.  The darn thing lost so much value since I started it, we decided to just do what we had to for our family.  

[JenniferAndJack]

I would hold off until the very last minute to do this.  Getting the money out of your 401k is easy & fast.  So don't pull it out until the dam is ready to break.  I converted mine to an IRA & pulled the money out when I needed it (think of these accounts like savings accounts that have penalties & tax consequences).  Call up your broker; he’ll explain the basic logistics for free.  Or Google it, once you read a little you'll see that it's pretty basic.

[MacroMama]

I would never recommend taking money out of a retirement account.

Aside from using the money in the future and the penalties, the money there is protected in case you ever have to declare bankruptcy. If the financial situation is that dire, then could the situation continue being dire in the future? If so, you would only be delaying the inevitable and have no retirement funds.

It is nice to think that your DH will get a job as soon as he finishes his training, but what if he doesn't?

Like you said, possible money in the future doesn't pay the bills now.

If your DH's employer doesn't match his 401K, then there is no reason to continue contributing to it. Instead, contribute that amount of money to your expenses and eventually when you are more financially sound, put it in a Roth IRA. That allows you to withdraw the money that you contributed without any penalties, although, once again, it would be best to leave it there so it can grow.

One additional reason why it is not advisable to take out loans from a 401K, is because you pay back that loan with after-tax dollars. Then, when you take it out in retirement, you have to pay taxes on it again. So essentially, you are paying taxes twice.

Good luck!

[ellairiesmom]

One additional reason why it is not advisable to take out loans from a 401K, is because you pay back that loan with after-tax dollars. Then, when you take it out in retirement, you have to pay taxes on it again. So essentially, you are paying taxes twice.

Good luck!

True, but these taxes could end up being minimal compared to the high interest you pay if you end up living off a credit card because of lack of cash to survive or incur late fees for other bills etc.  It's such a tough decision but again, it depends how bad things really are.  If you can't pay the power bill or for basics like groceries, what good is a retirement acct?  

[MacroMama]

Originally Posted by ellairiesmom 

True, but these taxes could end up being minimal compared to the high interest you pay if you end up living off a credit card because of lack of cash to survive or incur late fees for other bills etc.  It's such a tough decision but again, it depends how bad things really are.  If you can't pay the power bill or for basics like groceries, what good is a retirement acct?  

Well, for the future.

It really depends on the situation. If it is a temporary situation, then perhaps for some people it makes sense.

But if it is just postponing the inevitable, then it's better to rack up the credit card debt that can be discharged in bankruptcy, then not have your retirement account AND have to declare bankruptcy.

[lilyka]

I would leave it.  It doesn't sound like that much.

Stop contributing.

Look for a new fund to invest in because it should be making something.  mine is making 12% and my company matches.  Find a better fund.  

Can you take a part time/full time job overnights so you don't need childcare.  This low end.  I used to teach preschool and I was good at it and I loved it.  But working at the coffee shop makes twice as much before tips (seriously).  Look beyond (or below) what you went to school for.  I stocked shelves and made more money that I did teaching preschoolers.  And the beauty of the shelf stocking gig was that it was overnight so no child care, I could get 40 hours in 4 days (my manager let me skip my lunch break and keep working which gave me four extra hours a week).  I never saw my husband (not gonna lie, this goes in the bonus list) but I think for a season this could work for you. Some overnight jobs even allow you to sleep.

[Ellien C]

I'm in the camp to discourage taking it out, but to suspend contributions. At your income level, anything will help, including suspending contributions and your job. That could be like an extrs $200 a month. Surely that would help a lot.

[Subhuti]

We may have to take out from the 401K to pay for COBRA ... I think the penalities and taxes are waived then?  That is what my DH said that our accountant said ... but I don't know.

[Caneel]

Originally Posted by Subhuti 

We may have to take out from the 401K to pay for COBRA ... I think the penalities and taxes are waived then?  That is what my DH said that our accountant said ... but I don't know.

Correct, you will not pay any taxes or penalties as long as you repay the loan.  If you default on the loan, it will be treated like a withdraw. 

[A&A]

It depends.  We took some 401k money out (for braces) right before the 2008 crash. Perfect timing!  The "standard" advice is to never touch your 401k, but that assumes a bull market.  Who knows what the future holds, especially with a debt ceiling looming over our collective heads. 

[Subhuti]

Originally Posted by Caneel 

Correct, you will not pay any taxes or penalties as long as you repay the loan.  If you default on the loan, it will be treated like a withdraw. 

Hmmm.. We were told it was penalty and tax free ... There was no mention of structuring it as a loan.

[Caneel]

Originally Posted by Subhuti 



Hmmm.. We were told it was penalty and tax free ... There was no mention of structuring it as a loan.

There very well may be new rules about withdraws for specific life events.  I do remember reading a while back that certain things qualified for penalty free withdraws and Cobra payments may very well be one of them.  The HR department should have the up to date information.  Just be sure to ask for everything in writing so you have the supporting documentation at tax time.

[Subhuti]

Thank you, that is a very good suggestion.

:)