This goes in the "I shouldn't have to discuss this but I will in case anyone's thinking of doing it" category. This piece from the Seattle Times tells us why we should only withdraw money from our 401ks as a very last resort:
People hard up for cash may be tempted to tap their 401(k) accounts and other company-sponsored retirement plans. But this should be a last resort, not only because they face possible penalties but also because it undercuts their long-term security.
"This money is going to determine how you live in the long run," said David Wray, president of the Profit Sharing/401k Council of America, based in Chicago. "So if you can deal with short-term emergencies out of short-term resources, that's a better planning approach."
Better options for raising cash in an emergency include borrowing from relatives and friends, tapping a home-equity line of credit or seeking a personal loan from a bank or credit union, experts say.
Company 401ks and other retirement accounts are inviting targets because in many cases they represent a worker's biggest pool of savings, and most company plans allow for loans or "hardship" withdrawals. But because these accounts are funded with pretax income and grow tax-deferred, there are penalties if they're tapped early — before a worker turns 59 ½.
Wray said if a retirement account is a desperate family's only possible source of emergency cash, it first should consider borrowing, rather than withdrawing, from the account. "You can borrow up to half the account balance or $50,000, whichever is less," Wray said. "But if you borrow, you have to repay, typically through a payroll deduction."
Those payments are due at least quarterly, and they include interest, generally set at a percentage point over the prime rate, which currently is 6.5 percent. The interest goes back into the account.
Workers who choose the other alternative, hardship withdrawals, won't get nearly as much money as they hope. Companies withhold 20 percent of the amount withdrawn and send it to the government to help cover the taxes.
That amount, Wray said, probably won't fully cover the taxes and the 10 percent penalty, so the worker will owe still more.
The piece then goes on to suggest alternatives for raising much-needed cash:
Stephen Brobeck, executive director of the Consumer Federation of America in Washington, D.C., suggests families work on two fronts — raising money and calling on creditors to defer payments on bills. "If you ask for understanding and relief from credit-card companies and mortgage companies, the cash you raise will go farther," Brobeck said.
He said families should seek loans from relatives and friends who are likely to be generous when there's been a disaster.
Brobeck said piling debt on credit cards should also be a last resort. "It could be very expensive, because cards typically carry rates of 17 to 18 percent, and that can kick up to 28 percent or higher if you're late with a payment," he said. Penalty interest of 28 percent on a $10,000 card balance can result in $2,800 in interest accumulating in just the first year.
Another way to raise cash is to tap assets, for example, by taking a loan against a life-insurance policy or drawing on a home-equity line of credit. These loans generally carry much lower rates than credit cards.
Some families may also seek loans from a bank or credit union.
In many emergencies, there just aren't a lot of great choices for raising cash. But taking money out of your 401k is one of the least desirable options, so consider the consequences fully before you decide to take this option.
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