(NewsNation) — A 401(k) is one of the most common employer-sponsored retirement accounts.
Employees can allocate a percentage of their paycheck to automatically save in a 401(k), and some employers may match their contribution.
The money is invested into an account managed through an investment company, such as Fidelity Investments, Charles Schwab and Vanguard, to name a few. The money will then grow based on the investment market.
What happens if you do an early 401(k) withdrawal?
If you take out the money before age 59.5, you may have to pay taxes for the early withdrawal.
“It will likely cost you a 10% federal penalty and often an additional state penalty. On top of that, you have to pay taxes on all the contributions and gains that you withdraw,” according to Intuit TurboTax, an online tax preparation service.
An early withdrawal of $50,000 would carry a $5,000 penalty in federal taxes. It would also be taxed on your state income tax return.
“It usually doesn’t make good financial sense,” TurboTax said.
Can I take out a 401(k) loan?
A 401(k) loan can be an alternative to an early withdrawal if you need cash right away. While an early withdrawal has tax penalties, the loan does not.
Similar to taking out a bank loan, you can take out a loan from your 401(k) retirement savings account.
As long as you repay the loan on time, it will not be taxed, and “it will likely have little effect on your retirement savings overall,” according to TurboTax.
Hardship withdrawals
In certain circumstances, you may be able to avoid the penalties for an early withdrawal. This is called a hardship withdrawal, which is limited to only the amount needed to cover the costs associated with a hardship. It must be an “immediate and heavy financial need,” according to the Internal Revenue Service.
A financial hardship can include medical bills, avoiding eviction or foreclosure, funeral expenses, college tuition and fees, and certain home repair costs.