Ten percent from my reading, 401k early withdrawal penalties

This is a question for your financial advisor and tax accountant, not an online design forum. There are huge financial implications, both short and long term, for what you're considering doing. Eyes wide open, my friend.

P.S. It's possible you cannot afford to renovate your home.

@jrb451

At age 40, there is a 10% penalty for early withdrawal from the 401k (assuming it is even allowed). There is the regular income tax (both federal and state) on top of that.

"For those of you who took from your 401k to....."

I admit to not being a person who you want to hear from, because I would not borrow from a tax-advantaged retirement account to do a reno or even to pay medical debt or buy a house or pay for kids' education or anything like that. I would never do it because for one thing, the money invested is not earning tax-free interest for the entire time before you repay it, and for another thing, you DON'T KNOW the unforeseen risks in your financial situation between now and the time before you repay it.

I wouldn't even borrow from a retirement account to get professional tax advice! The answer is easily googled, and you can check the answer at the IRS website. Here's one link:

https://www.irs.gov/retirement-plans/considering-a-loan-from-your-401k-plan

You can go to online 401k calculators to see the difference this loan would make to your overall retirement plan, given an assumption that the money is repaid within the time allotted by the IRS. You might be surprised by the difference overall in your expected retirement savings at retirement age. Or, you can go to an actual tax professional to do these calculations for you.

You've got a good start on retirement savings, but you are not done yet. It is not important for long-term planning to live in a remodeled home.

Oh my goodness yes, ditto to @einportlandor advice!! The value of your 401K today is irrelevant unless it’s 100% cash. What if you borrowed too much & suddenly the market tanks? Don’t laugh - it has happened. If you cannot afford a Heloc or 2nd mortgage -both of which are bad ideas anyway - you cannot afford a costly reno. Hopefully you have accessible reserves in the event of job loss or uninsured emergency. If not, you must be in the living paycheck to paycheck category and many high income earners are because of high indebtedness. Understandable that your home has increased in value but know that values fluctuate. Better plan might be to double up mortgage payments & pay it off. And, so you have a 401K, great for you. What other retirement savings do you have? One income stream is not enough. Apologies if my strong opinions offend but my career was in credit - consumer and commercial - lending new money & collecting of bad debts. I think I have seen enough disasterous and great financial situations that I can say I do ”know whereof I speak“.

Don’t touch your savings. I would take out a Home Equity loan on your house to do the repairs vs. taking money from a qualified account that will cost you money in tax penalties. But yeah, talk to your financial planner for more solid advice.

I would not touch it either. If your house has increased that much in value, maybe now is the time to sell it, and buy one you dont need to remodel.

Often, you can borrow from your 401K. Usually, you pay the interest back to the 401K. The catch is that if you don't repay in time, you get whacked with the taxes and penalties. If it's a company plan and you lose your job, you might have to pay the loan back immediately.

But, certainly, I'd borrow from the 401K before I made a withdrawal.

In general, you'll have to pay 1 or 2% above the bank prime rate, which is 7.8% today, so my guess would be your interest rate is going to be around 9%. An early withdrawal has a 10% penalty plus it gets taxed as income. If you're in the 15% tax bracket, you're going to be paying a total of 25% on that withdrawal (10% penalty + 15% tax). And you be looting your retirement. With a loan, the interest is paid back to your account. A $10K withdrawal would net you $7,500, which is not a good deal.

It's certainly worth asking your 401K provider about the terms of a loan. That said, if you can't afford a home equity loan, you might not be able to afford this, either. In which case, I'd only do it for a needed repair, like fixing a leaky roof.

The other advantage of a 401K loan is that, since you're borrowing the money from yourself, you generally don't have to do much to qualify for the loan and often your credit rating doesn't matter. If your credit rating is bad, it might be a decent option.

Go online to where your 401k money resides and simulate a loan. It should give you the interest rate, how much you can take, how much you will pay back per pay period and how long it will take to pay it back.

I agree that if you can't afford a Heloc or 2nd mortgage you might not be able to afford this, however, you can lower your current contribution percentage and use that to help pay the loan.

At 40 a 401k joint account of 400,000 is not necessarily enough without even withdrawing. The suggested aim is to have at least three times your yearly combined income. If you are short of that target you should not borrow against or withdraw from the account unless an absolute emergency arrises. Even if you are within the suggested 401k target, taking out your money at a 25 % tax/penalty is way more expensive than paying interest rates on a loan.

If I had doubled the price of my home in four years, I might consider selling it and either renting or purchasing a less expensive home that does not need any repairs. How does that sit with you?

The only issue is that unless downsizing one sells higher but also has to buy higher and also likely at a higher interest rate so might actually not get a better house in reality. The best advice I can offer is to only spend on upgrades you can afford and do the needed things, like roof and plumbing, before the wants.

There’s no additional penalty if we select the general purpose loan for the 401k versus the actual withdrawal. So looks like we may do the GP loan against the 401k. Just up to 50k. The withdrawal there is 10% penalties- GP- none.

Getting a 2nd mortgage is way more expensive. And the money doesn’t go back to us.

We have a 403b and teacher retirement pension account too. (One of us)

I would have to disagree about only having one income- there are many people who live off one income. We happen to have two.

There is no rental option or house to purchase in our town that is cheaper… everything rose in price and we literally are sitting on gold. Kind of stuck bc of kids in school system. A two bedroom condo in town is 1.2 million and taxes are 5k more than ours. HOA is insane. We can buy a tear down for 1 million but those are going fast and getting all cash offers.

If you can afford to pay the 401k loan with in the at best five year allotment then yes it is a possible way to go. Unlike a bank loan, if you become unemployed by the company your 401k is with you need to pay it back generally before you file your next return. But you mentioned not being able to afford other loans. Your initial question sounds like a withdrawl not a borrowing against situation. Good luck.

Jes -you did ask for advice & you got it. It sounds like you plan to ignore 99% of it and also sounds like you didn’t do your own research about your 401K rules first before asking for said advice.. My advice doesn’t change even with that rule info that you’ve shared with us. It still sounds to me like you’re living beyond your means. But, should you decide to press on with a loan for your reno, my last bit of advice is to get all of the cost info for your reno & commit to a strict budget that includes a contingency amount for cost overrides which you will surely have no matter how well you plan. Good luck to you,

“So looks like we may do the GP loan against the 401k. Just up to 50k.”

How can you afford the payments on a 401k loan if you can’t afford a second mortgage? That doesn’t make any sense. I mean the payment on the $50k, standard 401k loan is going to be about $1,025 per month. The payment on the second mortgage would be about $350 per month. In what world can you afford $1,025 but not $350?

Another point to realize is that by withdrawing 50k you will fail to have that money grow at the usual 3to8% rate in which a 401k is expected to generate. This is not an insignificant amount of change!

Are the renovations unanticipated? How did you originally decide to purchase a house that needed work and not have a budget to pay for it?

It is hard because you are not really sitting on a pile of gold if the value of the house is not of use to you now and you are going to go into debt to live there. Sounds like perhaps this is one of those trade off as to whether you have the school district you like or the ideal house. You might not be able to have both.

I thought I would try to answer your question. Early 401k withdrawals are assessed a 10% penalty plus taxes are withheld (typically 20%). The taxes withheld are not likely to cover the tax liability on a large withdrawal.

If the entire withdrawal is in the 22% tax bracket ($96,951 - $206,700 for MFJ) and your state tax is 5% then you would need to withdraw $68,500 and be assessed a $6,850 penalty which will reduce your 401k by $75,350.

Sometimes people are forced to take an early distribution from retirement accounts, but it really should be a last resort.

For a $50K loan, the 401K loan might be cheaper. A second mortgage will come with the need for an assessment and points --- significant upfront costs. Further, if the borrower has a poor credit rating or lots of debt (student loans and medical are biggies), then the cost of a second mortgage would be high.

I'd advise the OP to look at all the options and do the calculations and decide what they can afford and what's the best option. The math is not that difficult, if you get the lenders to do it for you.

@Sigrid said, "For a $50K loan, the 401K loan might be cheaper. A second mortgage will come with the need for an assessment and points --- significant upfront costs. Further, if the borrower has a poor credit rating or lots of debt (student loans and medical are biggies), then the cost of a second mortgage would be high."

A 401K has a standard 5-year payback, while a second mortgage has a 30-year payback. There might be a few 401K's that will do a 10-year payback but you are certainly going to be paying an extra point for that. The rates on a second mortgage are lower than a 401K loan, currently a 30-year second mortgage is 7.25% - 7.65%, while a 5-year 401K loan is an 8.5% - 9.5% adjustable rate.

If the OP can't afford to pay a second mortgage (which they noted in the original post) there is no way they can afford to pay a 401k loan. You are talking about $350 compared to more than $1,000...

Also that fifty borrowed from an 401 will no longer earn between 5 to 8% interest which is similar to interest rates paid on bank loans so really not ever a better choice. Borrowing from 401k usually should be a last resort or for emergencies.

Two incomes, million dollar house and you don’t have $50000 in savings? You can only save $2500 a year? 40 is a great age to meet with a financial planner, not a bank employee, not the guy that works for the 401k, but an actual wealth manager, and from your description of your town I’m sure you have options. Be brutally honest and forthcoming with them. Its like you wouldn’t forgo having a primary care doctor because you can diagnose medical issues yourself.

@bry911

I noted that they might have issues that prevent them from getting decent mortgage interest rates. It depends on their credit rating.

You note, I suggested that they find out the terms of their options and do the math.

@Sigrid

Their credit and the rate on an equity loan are largely irrelevant. In the end, a second mortgage can be amortized over thirty years and a 401K loan is amortized over five years. If the second mortgage was 12% (which it would not be) the payment would still be half of the 401K loan.

If they can’t afford a second mortgage, then there is no mechanism for them to afford a 401K loan.

Having said that, even with bad credit the second mortgage is a going to be a comparable rate right now.