ST. PAUL — With more than 120,000 people across Minnesota applying for unemployment since last Monday due to the coronavirus pandemic, and that number sure to grow over the next month, many are searching for ways to make ends meet.
That includes potentially tapping into an existing 401(k).
What does that entail? What are the immediate repercussions of doing so? What impact could that have in the long run?
The Pioneer Press reached out to a couple of local financial advisers to find out and both agreed that it isn’t the best option.
“I think 401(k) should be a last resort,” said Ujae Kang, owner of UAK Diversified in Eagan. “There’s so many negative consequences that come with it.”
“It’s not a good idea,” added Lauri Salverda, owner of Castlerock Financial in Mendota Heights. “It’s also hard to tell someone that if it’s their only option.”
There is a 10 percent penalty for withdrawing from an existing 401(k) before reaching age 59 1/2. You also have to pay taxes on the money taken out.
For perspective, if someone were to withdraw $50,000 from their 401(k), they would instantly lose $5,000 in penalties, and on top of that, would have to pay taxes on the remaining $45,000.
“You might take out $50,000 and end up with $25,000 when it’s all said and done,” Salverda said. “That’s why it’s something we strongly advise against.”
There are some exceptions that allow a person to take a portion of their 401(k) without paying the standard 10 percent penalty. That said, each employer plan is different, so it’s important to figure out what falls under this umbrella.
Some of the general exceptions include: educational expenses like tuition, medical expenses, costs related to buying a house for the first time, costs related to avoiding foreclosure or eviction, and funeral expenses for deceased parents, spouse, or dependents.
You still have to pay taxes on the money taken out, even if the 10 percent penalty is waived.
As of right now, job loss due to COVID-19 is apparently not considered an exception. Or at least not yet.
“I would think it happens at some point,” Salverda said. “Until there’s some sort of legislation that says that for sure, though, then people have to assume it’s not part of the exception.”
Perhaps the most important thing to note is that the money lost can also be deceiving on the surface.
You don’t just lose out on the 10 percent penalty and the income tax when withdrawing from 401(k). You also lose out on potential growing down the road.
“If my clients were to ask to withdraw from 401(k), we would ask if they could borrow from a relative instead, or even use the credit card,” Kang said. “If none of those resources or available, maybe there is no choice.”
If anyone would know, it’s Kang, who liquidated his 401(k) during the financial crisis.
“It’s very tempting because the money is right there and people feel like they can grab it,” Kang said. “If I would have left it there it would have almost quadrupled by now. I could have easily gone to my family or friends to borrow money. I was too proud to ask, so I just tapped into my 401(k) and I really regret it.”
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