Many people are already familiar with the 401(k) retirement savings account. This is one of the most famous retirement savings options that employees have. This is because of the comprehensive benefits and flexibility it provides to the account holder to ensure a safe and secure financial future. Here, people have various options for accessing funds, and they often want to know which is better: a 401(k) loan vs 401(k) withdrawals. This is a very important factor to understand.
Both options have their own pros and cons and come with different usage aspects. As the 401(k) is very famous, knowing its inline concern will lead to a perfect retirement life with long-term growth potential.
Understanding 401(k) Loan and 401(k) Withdrawals
Before going to the main concern, let’s understand 401(k) loans and withdrawals. The 401(k) is an account that is used for retirement savings. Because of its specific features, this account is one of the best options for this purpose.
What is a 401(k) Loan?
A 401(k) loan is like a normal loan, which is available only for the account holder. Despite withdrawing money directly from the account, the plan administrator provides this feature. The account holder can borrow upto $50,000 or 50% of the saved value in this retirement account. Here, the borrower has to repay the loan with the defined 401(k) loan interest rates in the given timeframe.
This loan is provided by the plan administrator or the employer under which the employee is working. Here, people ask, Will my employer know if I take a 401(k) loan.
What is a 401(k) Withdrawal?
The 401(k) withdrawal, which is sometimes called a hardship withdrawal, is the way to withdraw funds directly from the 401(k) account. Also, in case of sudden money need, you can use this option for instant withdrawals and management of current crises. However, this is not like a regular withdrawal but imposes some fines and penalties, which we will discuss further.
For more details on the article, What is a 401(k) account?
401(k) Loan VS 401(k) Withdrawals: Which is Better?
Now here we are with our main concern. So if you are asking, Is it better to take a withdrawal or a loan from a 401(k) then the simple and straight answer is that the 401(k) loan is a better option than withdrawing directly. For a better understanding, below are listed the pros and cons of both system. Based on your financial needs and experts’ advice, the options will be chosen. Below is the difference between a 401(k) loan and a 401(k) withdrawal.
401(k) Loan
As mentioned, it is offered by the plan administrator to the account holder to borrow funds from the vested 401(k) savings. Vested saving or vesting means the ownership of the employee over the savings in the 401(k) account. Let’s understand that the contributions made by the employee in this account are always their own, but to get complete ownership over the contributions and the employer’s match, the employee needs to complete a specific period of employment.
Pros
- Mostly the 401(k) loan does not require any credit check by the account holder. This is because this borrowing is like taking loan on your own money.
- This loan comes with very low interest rates as compared to other loan options.
- One of the best and most major feature is the interest you pay will be deposited in the 401(k) again. This will help in maintaining the retirement growthing potential.
- The repayments are automatically paid from the payrollls only.
Cons
- If some of the amount remains unpaid then this will become a hardship withdrawal.
- In the case of job switch or leaving, if you have outstanding 401(k) loan then you have to repay it suddenly and in full.
- Repayments are made from after-tax dollars.
401(k) Withdrawals
401(k) loan vs 401(k) withdrawals is very important to understand this is because there are various questions arise in this like should you take a withdrawal or a loan from 401(k), etc.
The 401(k) withdrawal simply means to withdrawal or make a distribution from the 401(k) account. It is a direct cash out from the 401(k) using the employer’s defined distribution options. But mostly this options is not suggested until a very urgent need is there.
Pros
- In the case of urgent fund requirement this can be a good option with no repayment required.
- Can help in getting relief from high interest idebts and interests.
- Also, if you lost your job or leave then there is no need of sudden repayment.
- In some qualified situations, hardship withdrawals may allow you to withdraw without penalties or low taxation.
Cons
- One of the major disadvantage of direct withdrawal is the amount you withdraw will get reduced from the retirement savings and cannot be re-deposited in the account again.
- If you are under the age of 59½ years, then the withdrawals are considered as an early withdrawal, and this will impose a 10% penalty with the regular tax implications.
- The distributed amount will reduce the retirement savings significantly and the investment growth will also be reduced.
- The withdrawal will be included in the annual income, that increase the overall tax implications.
If we consider all the points, then the conclusion is that it is better to have a 401(k) loan instead of making a direct withdrawal from the 401(k) account. So, the topic 401(k) loan vs 401(k) withdrawals can be understood from here. However, there are some other issues that we will discuss further.
Which is Better for Debt Repayment: 401(k) Loan or 401(k) Withdrawals?
Making any distribution from the retirement saving accounts, like 401(k) or IRA is not advised at all until a series of urgent money needs arise. If the question is about debt repayment through the 401(k), then the 401(k) loan could be the best option to pursue. This is because the direct withdrawal will reduce the retirement savings for forever. Which means the distributed money cannot be redeposited in the account again.
Also, the 401(k) loan comes with an interest rate, but the interest will also get deposited in the account. So, the growth potential is affected very littel and also the borrowed money again got deposit so their is very less chances of retirement reduction. However, sometimes the direct withdrawal or hardship withdrawals makes sense. In situations of urgent money need and you cannot afford monthly repayments or qualified medical reasons.
So, before making any decision consider all the situations and your requirement. This will help in choosing the best options that empower the retirement saving while help in debt management.
Key Differences Between 401(k) Loan vs 401(k) Withdrawals
Below is mentioned the key difference between the 401(k) loan borrowing and the 401(k) withdrawals:
| Based on | 401(k) Loan | 401(k) Withdrawals |
| Penalties | The 401(k) loan is associated with no penalty unless the repayments are made smoothly. | A 10% early withdrawal penalty may occur if you are under the age of 59½ years. |
| 401(k) loan vs 401(k) withdrawals tax | There are no tax implications present in the 401(k) loan if repaid on time. | The 401(k) withdrawals are taxable, and the regular annual tax implications are imposed on them. |
| Repayment | The loan is required to be repaid. And the repayment is made from after-tax income. | No repayment is there. Even the direct withdrawal does not allow direct deposition. |
| Impact on Retirement | The 401(k) loan does not affect the retirement savings a lot because the repayments, including the interest, are again deposited in the account. | This affects the retirement savings significantly because the withdrawal imposes a 10% penalty, and the distributed amount cannot be redeposited. |
Is It Smart to Use a 401(k) for Debt?
When we understand the 401(k) loan vs 401(k) withdrawals, another major concern arises. Can I use my 401(k) to pay off debt, and is it simply a good option? However, the answer is not just simple. This is because disturbing the retirement savings is not advised at all. Retirement is a phase of life where no income source is present. Only the saving you have accumulated in the form of retirement savings is the source of living.
Paying off debt using the 401(k) account funds is not an optimal choice because this will significantly affect the retirement savings. However, if you are facing a severe repayment schedule or high-interest debts, then you can use these funds. But always consider all the factors and long-term planning to avoid future issues.
So, it is not about good or bad decisions because making any type of distribution from the 401(k) is always a bad choice, but sometimes the situation requirements are very serious.
Conclusion
The 401(k) loan vs 401(k) withdrawals is now clearly answered. For best results, it is not advised to make distributions from the 401(k) account in any way, even using the 401(k) loan. However, if the demand of the situation is really very serious, then the best way to access funds without affecting the retirement is taking a 401(k) loan.
This is because the repayment helps in re-depositing the funds into the account again, which is not possible in direct withdrawals. Also, the interest paid using the instalments is being deposited in the 401(k) account that maintains the growing potential.
Frequently Asked Questions
What is the smartest way to withdraw a 401k?
If you are under the age of 59½ years, then withdrawing from a 401(k) is not advised at all. However, people after this age can pursue various methods, like withdrawing based on their monthly expenses, to ensure long-term sustainability. For better results in inflation, you can also consider other retirement incomes and pension plans.
Can you withdraw from a 401(k) if you have a loan?
Yes, it is possible to withdraw money from a 401(k) account while having an open or outstanding 401(k) loan. However, this depends on the plan’s rules and the available 401(k) balance. This means the 401(k) loan and the 401(k) withdrawals are both separate processes and transactions.
What is the difference between a 401(k) withdrawal and a loan?
The main difference between a 401(k) withdrawal and a 401(k) loan is that the withdrawal means the money will be deducted from the account and cannot be redeposited. However, in the 401(k) loan, the money will again get repaid through the monthly instalments in the account and the interest also gets deposited in the account.
