I want to access my 401(k) early. Is a loan the only way?

by user


Dear Dan,

I must be missing something. I don’t want to take a loan against my 401(k) because the interest rate charged is too high, but my plan representative says a loan is the only way to get to my funds. Is that true? Are loans the only way to access 401(k) funds?

Dear reader,

The law provides for many ways to access funds in a 401(k) plan but, it may very well be true that in your circumstance, a loan is the only way for you to tap your 401(k) account.

The distribution rules for 401(k)s and other retirement plans are intended to discourage participants from accessing funds prior to retirement so that the funds can accumulate. Plans must follow the rules or risk sanctions including fines or plan disqualification.

Plans cannot permit distributions until there is a distributable event. What constitutes a distributable event can vary from plan to plan but all plans must allow distributions at the participant’s death, disability, or if the plan terminates.

Most plans allow you to take a distribution when you stop working for the company sponsoring the plan. However, under Federal law, your plan can prevent you from beginning to receive benefits until the later of reaching age 65 or the age your plan considers to be normal retirement age (if earlier) OR 10 years of service, OR terminating your service.

In addition, 401(k)s may choose to allow “in-service” distributions which do not require severance of employment but come with some restrictions. For instance, elective deferrals (the funds you contribute from your pay), including elective deferrals to a Roth account, cannot be distributed in-service prior to age 59 ½. However, plans may permit rollover contributions made into the 401(k) to be rolled out at any age. Again, that is if the plan document provides for such an in-service distribution.

Barring a distributable event, the next option that may be available is a hardship distribution. Plans are not required to allow hardship distributions. If the plan does allow them, they are only available if the participant has an “immediate and heavy financial need,” and the distribution cannot exceed the amount “necessary to satisfy” the financial need.

So, if your situation does not fit with what your plan allows, it is entirely possible that the only option left for you to access your funds is a loan. If you take the loan, just keep in mind that if your employment ends and the loan is not paid off in time or you default on payments, the outstanding loan amount is treated as a distribution. This means it will be taxable and if you are under 59 ½, an additional 10% penalty will apply unless an exception applies. 

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line. 

Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.


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