Tips for Keeping Your 401K on Track

Even when you’re dealing with economic hardship or are troubled by the economy, it’s important to keep your savings strategy on track and keep contributing to your 401k account. 401k plans are designed to provide you with financial security when you are no longer able to earn an income with a regular job. Whether you choose to retire early or are planning for a standard retirement, it’s important to set up a 401k contribution plan and savings strategy that works for you in the long-term.

For many people who are employed full-time, the 401k account is already set up and their company is contributing to the account along with their regular contributions. Those who are self-employed or want more control over their 401k account will need to seek out the help of a financial advisor so that they are making the right choices with their investment strategy.

Here are some important tips for keeping your 401k on track:

1. Contribute more when your income goes up. If you get a salary increase at any point in your career, make larger contributions to your 401k. Some employees are subject to automatic increases for their 401k plan contributions when they get a raise, so find out if you are eligible for this by checking with your human resources representative. If the increase is not automatic, you will need to contribute more individually. Talk to a financial advisor on what this process entails so that you don’t miss out on the opportunity to build up your savings account.
2. Consider building your portfolio on your own. If you’re willing to take some time to learn about your investment portfolio, learn about the different investment options available to you so that you are making the best choices with your savings account. Sometimes the “default” options aren’t enough to prepare you for a comfortable retirement, so you may need to explore other types of accounts and investments. Talk to a financial advisor to learn more about your options.
3. Don’t withdraw money from your 401k at any time. Taking money out of your 401k account prematurely can prevent you from getting the highest return on your investment. Do whatever you can to avoid having to withdraw from your 401k account or you could end up paying high fees and a tax penalty on the balance. Consider as many alternatives as you can for coming up with cash you need, and protect your 401k.

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401K Hardship Withdrawal Options

The government provides a tax deferred 401K option in order to encourage you to save for your retirement. The government ultimately benefits from this plan because it reduces the burden placed on senior services, such as Social Security and Medicare. However, you may need the funds before you actually retire. Withdrawing directly from your fund will create large penalties, but there are options to tap into the savings without the penalties.

Borrow against your 401K

Some financial management firms offer ways to borrow funds using your 401K as collateral. The government does not require all providers to have this option; you should check with your 401K manager to see if you are eligible. These loans are not subject to the taxes assessed on 401K withdrawals. They are also not subject to the penalties assessed for withdrawing from your retirement fund before the age of 59 1/2. The government does not set restrictions on how and when the funds can be used. Your employer or your financial management firm may, however. There may be minimum loan requirements. You may also need to have all beneficiaries of your plan, such as a spouse, sign off on the loan.

Loan limits

Most employees are permitted to borrow up to 50% of their vested 401K balance. This is set by each employer, however, so you may be subject to different limits. The limits usually cap at $50,000. These limits are partially cumulative. This means, if you have borrowed against your 401K in the previous year, you will have to factor the other loan into your limits. You will only be able to borrow up to 50% of the amount with a limit of $50,000 minus your existing loan. All loans have a maximum 5 year maturity period. Home loans may have a longer period, however.

401K hardship withdrawal

If you do not want to pay the interest on a 401K loan, and you do not want to put your savings at risk, you may consider a hardship withdrawal. Again, these are not mandated by the government, so you will have to check your plan to see if you qualify. You will have to meet four conditions to be eligible:

1. You must have an immediate and severe need
2. You cannot get the funds elsewhere
3. You are only taking out enough to cover the need
4. You have already expended all of your loan options on your 401K

Once these conditions are met, you will only qualify if you are using the funds for one of five reasons

1. Buying a primary residence
2. Paying the cost of a tuition for you, your spouse or your child
3. Facing eviction
4. Miscellaneous severe financial hardship
5. Medical expenses

Hardship withdrawals are subject to taxes and a 10% penalty. You cannot return the funds to the account once they have been dispersed to you. This means you will permanently lose the ability for tax-free growth on the investment. You will essentially be losing an additional .30 to .50 cents of funds for each dollar you take out. Ultimately, hardship withdrawals make poor financial sense unless you have no other option to prevent a financial disaster.

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When can I withdraw from my 401K?

A 401K retirement plan is a specific, legal structure. Unlike a normal savings account, your 401K account is monitored by both your employer and the IRS. Whenever you make changes to this account, including withdrawing funds, you must do so according to the laws governing your account.

There is a minimum withdrawal age

Both the federal government and your employer provide you with the ability to have a retirement plan in order for you to save for the time you are no longer working. The advantages they offer, such as 401K contribution matching and tax-free contributions, are an incentive for you to save appropriately. This lessens the burden of social security and other needs you may have when you are no longer able or willing to work. The situation is a win-win for those involved; the government loses, though, when you withdrawal early. To stop you from doing this, the IRS sets a minimum age for withdrawal. This minimum age is 59 1/2 years as of 2009. Anytime you withdraw from your account or change your account, you will be subject to a penalty.

You pay a 10% penalty for withdrawing early

The standard penalty for early withdrawal from your 401K is 10%. The 10% is taxed only on the funds you withdraw. However, this can amount to a large loss if you take out a lot of money or make frequent withdrawals. There are some options to avoid the penalty. One option is to borrow against your 401K. Some lenders will accept the money in your 401K as collateral on a secured loan. When you do this, you do not forfeit those funds unless you default on the loan. Borrowing against the funds can supply you with the cash you need in the short run while protecting your retirement savings in the long run. You should be careful when borrowing against savings, though, because you can lose the money in your account and owe taxes and fees if you do default on the loan.

You pay taxes on your withdrawals

Any time you take funds out of your 401K, whether you are withdrawing early or after you have reached the minimum retirement age, you will have to pay taxes on the funds you take out. You did not pay taxes on the money when you placed them in the account, and this means you will have to pay the taxes on a deferred basis. So, if you withdraw early, you will pay the 10% fee plus 20% in taxes, or 1/3 of the monies you are taking out. To cover a $3,000 expense, you will have to take out $4,500 from your retirement savings. You should be careful with this rule when you are rolling your funds into a new retirement account. If you have the funds given to you in the form of a check before they are deposited into your new account, you will have to pay the tax penalty. Instead, it is important to move the funds directly into another retirement account instead of into your name.

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