Should I cancel my 401K and withdraw my funds?

Canceling your 401(k) contributions is easy to do. Go to your human resources department and make a request to stop contributions. Withdrawing money from your retirement account, however, may be more difficult. You may have to prove that you’ve had a financial hardship or leave your employer to access the funds.

Disadvantages of Cancelling Your 401(k)

Whether you should withdraw money from your 401(k) is another story. Your employer-sponsored retirement plan is designed to provide you with retirement funds, outside of social security. Contributing 5-15% of your income, with an employee match, over the course of your working lifetime should provide you with a substantial sum when you retire. Withdrawing even small sums will impact your nest egg’s growth potential.

Choosing not to make regular contributions will help you make ends meet now, but that might not be the best strategy to cover a cash shortfall. If you cannot pay your bills now while you are gainfully employed, how will you manage in your retirement years?

Your Retirement Money Is Safe From Creditors

Did you know that money saved in a retirement account is safe from creditors? If you are sued or declare bankruptcy, your 401(k) and IRAs cannot be liquidated by creditors to satisfy money you owe. If you’re having problem managing your debt, it’s better to seek other alternatives than an early withdrawal, which will also come with a high tax penalty (typically, 30-40% of the total).

What About Borrowing Money From My 401(k)?

It may seem like an easy way to get out of debt to borrow from your retirement accounts for DIY debt consolidation. You won’t face a tax penalty for doing so, like you would with an out-right withdrawal, but you’ll still have to pay the money back. And unlike a home equity loan where payments can be drawn out over a 10-30 year period, most 401(k) loans need to be paid back on a shorter time table – like 5 years. This can take a huge chunk out of your paycheck, causing you even further financial distress. Borrowing money from your 401(k) also limits the ability of your invested dollars to grow.

Paying off some of your debt with a 401(k) loan could help improve your debt-to-income ratio, a calculation lenders make to determine how much you can handle, payments-wise. If you’re almost able to qualify for a consolidation or home equity loan, but your ratio is too high, a small loan from your retirement account, amortized over 5 years at a low interest rate may make the difference.

Debt Relief Without Cancelling My 401K

Before borrowing money from your retirement account, consider other options like nonprofit credit counseling or a home equity loan. You may be able to access a non profit debt management plan where your payments are consolidated, without having to take out a new loan. A credit counselor can review your income and expenses and see if you qualify for debt consolidation without taking out a new loan.