4 min read March 16, 2022
5 better options for emergency cash than an early 401(k) withdrawal

Emergency expenses or losing a job could make it seem like raiding your 401(k) will help you get ahead. Don’t let a short-term need sap your retirement savings.

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It can be scary when suddenly you need emergency cash for medical expenses, or when you lose your job and just need to make ends meet.

The money squeeze can be quick and traumatic, especially in a more volatile economy.

That’s why information about an early 401(k) withdrawal is among the most frequently searched items on principal.com. Understandably so, in a world keen on saddling us with debt.

But the sad reality is that if you do it, you could be missing out on crucial long-term growth, says Stanley Poorman, a financial professional with Principal® who helps clients on household money matters.

The most severe impact of a 401(k) loan or withdrawal isn’t the immediate penalties but how it interrupts the power of compound interest (making money on your money) to grow your retirement savings.

In short, he says, “You may be harming your ability to reach and get through retirement.” More on that in a minute. First, let’s cover your alternatives.

Alternative ways to access emergency cash:

1. A bank or credit union loan

With a decent credit score you may be able to snag a favorable interest rate, Poorman says. But “favorable” is relative: If the loan is unsecured, that could still mean 8%–12%. If possible, secure the loan with some type of asset (such as a car already paid for) to lock in a lower rate.

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2. Home equity loan

With your home as collateral, you may get a better interest rate and a longer payback. It’s friendlier for your monthly budget. Beware how fees for appraisals and underwriting can add to the overall loan balance.

3. Home equity line of credit

Instead of fixed-term repayment, you get a variable repayment and interest rate. You may opt for an interest-only repayment, but most often that comes loaded with a balloon payment, Poorman says, and may be tough to afford. Keep in mind that with a variable interest rate loan, you could see your rates go up over time.

4. Zero-interest credit card

These offers may give you a cushion—but watch the terms: If the card’s interest is “capitalized,” that means once the initial offer expires, you could be on the hook for accrued interest during the offer period. This can dramatically increase your principal balance and make it even harder to eliminate credit card debt. That’s why it’s important to pay back the balance on deadline if you transfer debt through this kind of offer.

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5. 401(k) loan

Now we’ve reached the point of dipping into your 401(k)—stopping short of a complete withdrawal. On the surface it may seem to make sense to rid yourself of 15% or 16% interest on credit card debt. A 401(k) loan (with a $50,000 max or 50% of account)* technically is a better option because you repay yourself, although it still carries risk: If you leave your job, you must quickly return the full balance, typically within 60 days, or be taxed for unpaid balance.

Penalties for an early 401(k) withdrawal

A loan is more strategic than an early withdrawal from your 401(k), which torpedoes your savings altogether. With a full cash-out, you instantly lose a big chunk, paying an early withdrawal penalty of 10% as well as income taxes on your distribution. (There are exceptions to the 10% early-withdrawal penalty that could apply depending your age and work status; speak with a tax advisor about your situation.)

For instance, with a $50,000 withdrawal, you may keep just $32,500 (65%) and pay $17,500 (35%) in taxes and penalties (depending on your state and tax bracket). And the leftover sum you receive, if you happen to be in a higher tax bracket, may nudge you into paying even more taxes for that additional annual income.



Graphic showing that if you withdraw $50,000 from your 401(k), you may keep just $32,500 (65%) and pay $17,500 (35%) in taxes and penalties.

Read the IRS’ list of things to consider when making early withdrawals from retirement plans.

Emergencies can leave you with limited choices, but even the less extreme option of a 401(k) loan may paint your future self into a corner. The most severe impact of a 401(k) loan or withdrawal isn’t the immediate penalties but how it interrupts the power of compound interest (making money on your money) to grow your retirement savings.

If you absolutely must take a loan, avoid stacking loans (simultaneously burdening yourself with multiple loans). Some employer retirement plans restrict the number you can take.

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If you’ve already taken a withdrawal or loan, you can recover.

  • Build up a cushion of at least three to nine months of your income. No matter what incremental amount you save to get there, Poorman says, the key detail is “consistency and regularity.”
  • Set up automatic deposits to a savings account so you can’t skip it.
  • Put off bigger purchases that are wants not needs.
  • Save aggressively to your 401(k) as soon as possible. Bump up your 401(k) contribution 1% annually, until you maximize your retirement savings.
  • Sock away the money earned from any job promotion or raise.

Next steps

* Generally, the maximum loan amount is the lesser of (A) or (B): (A) 50% of the vested account balance, reduced by any outstanding loan balance, or (B) $50,000 reduced by the highest outstanding loan balance during the past 12 months. This includes all loans (new loans taken in the past 12 months, loans paid off in the last 12 months, and all defaulted loan balances, no matter how old the loan).

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel, financial professionals, or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Investment advisory products offered through Principal Advised Services, LLC. Principal Advised Services is a member of the Principal Financial Group®, Des Moines, IA 50392.

Insurance products and plan administrative services provided through Principal Life Insurance Company®. Securities offered through Principal Securities, Inc., member SIPC and/or independent broker-dealers. Principal Life, and Principal Securities are members of the Principal Financial Group®, Des Moines, Iowa 50392.