When times get tough and you’re out of work, you may be tempted to tap your 401(k) for living expenses.
Under normal circumstances, most experts would advise against this.
But these aren’t normal times…
Here’s What You Need to Know About Tapping Your 401(k) Right Now
Money expert Clark Howard has long discouraged people from taking money out of their 401(k) before they reach age 59.5. That’s the age past which you no longer have to pay a 10% early withdrawal penalty.
Yet the nearly unprecedented economic disruption we’re facing as a nation at this moment might make a different approach necessary for some, depending on their circumstances.
“If for all practical matters, you can’t put food on the table without drawing down some of your retirement money,” Clark says, “[then] you draw down some of that retirement money.”
Here’s the Smartest Way to Draw Down Your 401(k)
Under normal circumstances, if you ran into a financial jam, you could borrow against your 401(k). But if you’re reading this article, it may mean you lost your job. In that case, borrowing isn’t an option for you since you’re no longer employed by your plan’s sponsor (your ex-employer).
That means you have two choices: Either liquidate your holdings entirely and take the money out or roll it over into an IRA and sell a portion of it as needed for money to live on.
If push comes to shove, Clark favors rolling over to an IRA with one of these low-cost investing companies:
“Move that money over and then you’re in position if you need to draw down some of the money to live on,” Clark says. “The money that will be subject to tax and penalty will be only what you had to draw down for living expenses.”
The basic process of rolling over a 401(k) to an IRA is pretty straightforward:
- Contact the firm that administers your employer plan and tell them you’re looking to roll over your 401(k) into an IRA.
- Open an eligible account at a new firm (such as one of those above) to move the assets into. If you have an existing IRA, that will work, too.
- Once you set everything in motion, your old firm with the 401(k) will write a check to your new firm for the IRA.
If by some chance, the old firm mails the check to you — rather than to your new firm — you simply have to endorse it and send it over to the new firm within 60 days.
Clark’s Plan for Financial Triage
Drawing down money from your 401(k) is a choice that shouldn’t be taken lightly. But it might be a necessary step if you’re unemployed and unable to find work for a period of time.
If you’re going to take this drastic measure, you need to have a firm plan in place about how you’re going to spend the money.
Clark has a formula for determining which bills get paid when you have limited money. In short, his “financial triage” system helps you prioritize expenses related to:
- Unsecured debt (credit cards and personal loans)
Read How to Decide Which Bills to Pay First When You Have Limited Money for full details of his plan.