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4 alternatives to early 401(k) withdrawals

July 27, 2011

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

It's bad enough that U.S. savings rates have been critically low for more than a decade. Now, for many people, those savings rates may be going in reverse.

Economic hardship in recent years has led to an increase in the number of people tapping into their 401k retirement plans before they reach 59 1/2, the age at which 401k withdrawals are allowed. As a result, these people are compounding their financial difficulties by paying a 10 percent penalty on those withdrawals.

A new poll by MoneyRates.com and GetRichSlowly.org shows that even in tough financial times, a vast majority of people have avoided incurring penalties with early withdrawals from their 401k savings accounts. This example should help people who are considering such a withdrawal to find other alternatives.

Poll: Most preserve retirement savings rates

The MoneyRates.com/GetRichSlowly.org poll asked visitors to those sites whether they had found it necessary to tap into their 401k plans before retirement. Nearly a thousand people responded, and most of those with a 401k plan were able to avoid early withdrawals and the penalties that come with them.

13 percent of respondents had no 401k plan, so focusing on the respondents who did have a 401k, the poll found that 64 percent of those had never tapped into the plan. Another 19 percent were able to access money from the plan without penalty - most often by borrowing money from the plan and then repaying it.

This left just 17 percent of respondents with a 401k plan who had paid a penalty for accessing money in that plan before age 59 1/2. In order to avoid joining this unhappy minority, it is worth considering several alternatives to an early withdrawal from a 401k plan.

4 ways to preserve your 401k account

Before you incur a penalty for an early 401k withdrawal, consider these alternatives:

  1. Go into emergency mode as soon as trouble strikes. When people get laid off, they tend to preserve their old lifestyles as long as possible. However, since it can take a very long time to land a new job these days, the best approach is to acknowledge the situation and go into emergency mode as soon as possible. Better to take a temporary step back in lifestyle than suffer permanent damage to your 401k.
  2. Borrow, don't withdraw. Many 401k plans have provisions for borrowing from your balance, and it is also possible to borrow from an IRA. This isn't an ideal solution, but it does beat paying a 10 percent penalty.
  3. Target Roth IRAs first. You've already paid taxes on these contributions, so they are eligible to access without penalty.
  4. Compromise on your job demands. If you've lost your job and are holding out for an equivalent position, you may have a long wait. Consider a lower paying job - when you add in what you are saving by not paying a 401k penalty, it might not represent such a big pay cut after all.

The bottom line is that 10 percent is a huge penalty to pay for accessing your money - especially when savings account interest rates are less than 1 percent, and stock returns have been disappointing for over a decade. Since most people have been able to avoid this fate, it's worth doing everything you can to avoid it yourself.

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