401(k) plans are great saving plans that keep your money out of reach to certain limits and the accessibility to such payment is usually for an emergency. The common of such provision is a tax-free loan you can draw from your 401(k) savings and interest on this loan are paid to the same account. Furthermore, a critical emergency is considered for a hardship withdrawal, but approval is subject to income tax, and a 10% penalty is attached to it.
The appeal 401(k) loan gives may tend towards paying less attention to specific details that may not be to your advantage in the long run. The likely bait is that the borrowed principal and interest are paid back to you, therefore, nothing is lost, but there is more to this arrangement. You certainly lose money if the interest you are paying on the borrowed money is less than the profit that same amount of the money would have earned you in the plan. The effect of this development is that your retirement payment shrinks.
Another downside to this is that repayment comes from your after-tax earned money. Loans repayment must be made within five years and fifteen years for loans to purchase a home. Difficulty in loan payment may lead to discontinuing contribution to 401(k).
Withdrawal in the form of hardship withdrawal from 401(k) account is not always easy. You need to provide a strong reason why you need the money urgently, and it must be established that you are not qualified for a loan. Heavy financial need that usually warrants this form of withdrawal include the purchase of a residence, to avoid foreclosure on the principal property, to pay for medical expenses not covered by insurance, payment for postsecondary tuition and in some cases child support and funeral expenses. It must be convincing that the principal does not have any other means of meeting the financial emergency. The contribution is not allowed on the 401(k) account for the next 12 months after hardship withdrawal.
Tapping into 401(k) account is not an option to consider except for extremely difficult financial emergency that there is no other alternative to circumvent it. The effect of taking a 401(k) loan is bad for your total take-home, but hardship withdrawal is worse than the former.
Loan gradually eats up your investment in the account and payment still adds to your financial obligation. It can snowball to difficulty in meeting monthly contribution which can degenerate to the closure of the account.
Hardship withdrawal bears same weight on the account in a greater proportion. This is not to turn a blind eye to life eventualities that are unpredictable, but it calls for proper planning which warrants not putting one’s egg in one basket.