#AskGradMoney: Can I Use my 401(k) to Help in an Emergency
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"I'm worried that I may get laid off from my company soon, and I'm really concerned because I don't have much, if any, savings to get me through until I find a new job. Is it possible for me to dip into my 401(k) so I can afford to feed myself for the next year?"
First of all, I'm sorry to hear that you may be laid off: it's a reality that not many of us remotely think about, yet it's far more common that we ever imagined. Believe me, I know from experience, I've been laid off before as well. However, it is only temporary and you'll find a job much faster than you think. You can always find something quick if you look hard enough. Or if you start before you're laid off that's even better. I bring this part up, only because you said you "may" get laid off, meaning that you haven't been laid off yet. As soon as I fear I lay-off, I'd start the job search IMMEDIATELY, don't wait. Given that you don't have much in savings, it's going to be imperative that you replace that income ASAP, so before you get that announcement, get a job offer in hand somewhere else. Generally, with effort you should have something within 3-4 months.
Secondly, since you will likely be let go involuntarily (i.e. as part of a layoff and NOT quitting or being fired for whatever reason), you have the ability to apply for unemployment insurance in your state. The process varies by state, so be sure to check out their respective websites to see what you need to do. Generally, you'll be asked to fill out some paperwork and they'll do an interview to find out about your situation (either in person at an office, or over the phone). In some states, this can amount for up to $450 per week until you find a new job. While that may not be enough to cover your bills fully, it's still something. And you can fill in the gaps with savings or a part-time job at a restaurant or store. Also, though you should never plan on it, employers with larger companies generally have severance packages of some kind for their employees, and you may be lucky and get a decent one here. The idea here is that you have other income resources to use before looking at going into your retirement savings.
If you have exhausted all other options, you MAY use your 401(k) funds but only as a last resort. The reason is it is so costly to dip into these accounts that so few choose to do so. If you're under age 59 1/2, there is a 10% early withdraw penalty: meaning if you take $10,000 out of your 401(k), $1,000 automatically disappears in the form of a fee. Additionally, you will be required to pay income taxes on on that distribution since that money has not yet been taxed by the IRS (unless it was a Roth account). Plus, you may have to pay additional state and local taxes depending on where you live. That $10,000 distribution can easily turn into $5,000 or less without much to show for it.
But if you MUST take a distribution, keep a few things in mind:
1) Budget the use of that money WELL -- don't just take out an arbitrary amount that you can use to feed yourself, pay your bills, and ALSO take a trip to Europe or buy an expensive handbag. This money is to fill in the gaps that unemployment won't cover, so do the math and determine how much extra income you'll need to cover 3-4 months.
2) Be sure you're completely separated from your employer before taking a withdrawal, otherwise it will be considered a loan -- employers will allow you to borrow from your 401(k) with a bunch of separate restrictions, but that's another story for another day. Unless you're completely separated from you employer, the distribution will be considered a loan from the 401(k) and because it's a loan, you'll be required to pay it back, starting almost immediately and you're given (usually) 5 years to replace the money you took out.
3) Even if it's not a loan, have a plan on how to pay that money back -- that money is gone when you get to retirement and all the interest that goes along with it. Have a plan on how you're going to get that money back into your account in the future when you'll REALLY need it to feed yourself.
The biggest issue of all: your retirement savings have declined! You never want this to happen, especially if you're only a decade or so away from retirement because it will take a LONG time to make up that difference. Keep in mind that this is money you'll either have to save twice as hard to get back, or you'll have to completely forfeit in retirement. Not the thing to do.
Keep your head up and focused! You'll be on the path to a great new future in no time! GOOD LUCK!