What are the Pros and Cons of Making a 401k Withdrawal?

There are both pros and cons of withdrawing money from a 401K plan. As far as the pros are concerned, a person who takes a 401K withdrawal may quickly obtain money he needs to make large purchases or meet the cost of dealing with some type of hardship. If a person has retired, been laid off, or even been fired, a 401K withdrawal may help him meet daily living expenses. The cons, however, include less money for retirement, hefty income taxes, and early withdrawal penalties.

The purpose of a 401K plan is to save money for retirement. In most cases, people leave their contributions in 401k accounts until they reach 59 and a half, which is the minimum age for withdrawing money without penalties. Sometimes, however, an individual will decide to make a 401K withdrawal early, which usually requires him to pay not only income taxes on the money he withdraws, but also a 10-percent early withdrawal penalty.

One of the pros of making a 401K withdrawal is having access to the money in times of need. If an individual needs a large sum of money, such as for a deposit on the purchase of a primary residence, having a 401K plan to withdraw from can be an advantage. If an individual in this position doesn't have another source of money to use, having a 401K plan may mean the difference between buying a house or staying in his current residence. Sometimes a withdrawal from a 401K plan can also help avert serious financial problems, such as by providing money to pay medical expenses or handle daily living costs after a person has been disabled, laid off or fired.

For many people, the cons of 401K withdrawals outweigh the pros. For example, a 401K account holder may be pleased to learn he can make a withdrawal from his 401k plan. He may be less pleased, however, when he learns how much he will have to pay to do so. In most cases, making a regular withdrawal means a person has to pay income taxes on the money he withdraws. For example, if a person withdraws $50,000 US Dollars (USD) after he reaches the minimum withdrawal age and his tax rate is 20 percent, he may pay $10,000 USD to access his money; if he withdraws this money early, he may face taxes and a 10-percent fee, paying $15,000 USD to make the 401K withdrawal.

In addition to the taxes and penalties a person may face, early withdrawals also reduce the amount of money available for retirement. Though taking an early 401K withdrawal may help an individual handle current financial needs, it may also mean he’ll have less money left to live on when he is elderly. Additionally, early withdrawals represent a loss of interest as well.