Question - Does cashing out a 401k hurt your credit?

Answered by: Janice Ward  |  Category: General  |  Last Updated: 17-06-2022  |  Views: 580  |  Total Questions: 14

Accounts Not Reported. Employers don't report 401(k) activities to credit bureaus. That's both good news and bad news. You'll pay the 10 percent early withdrawal penalty and the federal and state taxes that you'll owe on the income, but your credit score will emerge unscathed. ANSWER: You should not take the money from your 401-K to eliminate your debt because $14, 000 will go to penalties and taxes – that's 40% of your savings. It's like taking out a loan with 40% interest to pay off your debt. I would never cash out retirement savings to pay off debt unless it is to avoid foreclosure. Answer: No. Loans from your 401k are not reported to the credit-reporting agencies, but if you are applying for a mortgage, lenders will ask you if you have such loans and they will count the loan as debt. It won't affect your qualifying for a mortgage, either. Since the 401(k) loan isn't technically a debt—you're withdrawing your own money, after all—it has no effect on your debt-to-income ratio or on your credit score, two big factors that influence lenders. Withdrawal penalties The first problem with hardship withdrawals from a 401k or traditional IRA is a 10 percent withdrawal penalty. If you take out $20, 000 to pay off your credit card debt, then you'll pay a $2, 000 penalty on both of these accounts if the money was taken out as a hardship withdrawal.

In general, when you make a withdrawal from your 401K before you reach age 59 ½, the Internal Revenue Service may charge you a 10% early withdrawal penalty. You'll also pay taxes on any amounts you cash out because these funds come directly from your pre-tax income.

A hardship withdrawal, though, allows funds to be withdrawn from your account to meet an “immediate and heavy financial need, ” such as covering medical or burial expenses or avoiding foreclosure on a home. But before you prepare to tap your retirement savings in this way, check that you're allowed to do so.

If you are over the age of 55, then you can actually take your money out of the 401k and the penalty will be waived under an early retirement exception. Even thought you cancel your contributions, your not allowed to withdrawal the money from the 401(k) unless you meet IRS requirements like termination of employment.

If you withdraw money from your 401(k) account before age 59 1/2, you will need to pay a 10% early withdrawal penalty, in addition to income tax, on the distribution. For someone in the 24% tax bracket, a $5, 000 early 401(k) withdrawal will cost $1, 700 in taxes and penalties.

If you leave a job, you have the right to move the money from your 401k account to an IRA without paying any income taxes on it. If you decide to roll over your money to an IRA, you can use any financial institution you choose; you are not required to keep the money with the company that was holding your 401(k).

Suppose that instead of taking a withdrawal you choose to borrow from your 401(k). Because it's a loan and not a withdrawal you won't pay taxes on it. However, those lower payments don't come without a risk. Generally you need to repay the whole 401(k) loan amount if you leave your job.

However, all that hard work is erased when making an early withdrawal. Across the U. S., there is an increase in withdrawals from 401(k) plans for non-retirement needs. The math behind an early withdrawal from your 401(k): An example case. Annual Rate of Return Potential Future Value in 30 Years 8% $150, 940

Internal Revenue Service rules prohibit workers from cashing out a 401(k) while they are still employed at the company that sponsors the plan. By leaving the company that sponsors the plan, you can cash out your 401(k) account even if you're currently working for another company.

Basically, hardship withdrawals mean you're able to take money from your 401k before you reach age 59 ½, but most of the time you will still be hit with the penalty. First-time home purchase: You can take up to $10, 000 out of your IRA penalty-free for a first-time home purchase.

Earnings in Your Roth IRA up to $10, 000 for the Purchase of a First Home: No income tax due, will not owe 10% penalty. Large 401k Loan (Limited to Half of Balance or $50, 000, Whichever Is Smaller): Will not owe income tax or penalty. Monthly payments can be large and substantially affect mortgage qualification.

There can be an immediate cost to cashing out a 401(k): federal and state income tax, and for those younger than 59½, a 10% early withdrawal penalty. If you run into financial trouble, a loan from your 401(k) may be an option. A hardship withdrawal (if the plan offers it) could be as well.

How much can you borrow? Plans can set their own limits for how much participants can borrow, but the IRS establishes a maximum allowable amount. If your plan permits loans, you can borrow $10, 000 or 50% of your vested account balance, whichever is greater, but not more than $50, 000.

Typically after a loan is paid back, you have to wait six months before you can take another loan.

Your 401(k) loan isn't technically a debt, so it has no effect on your debt-to-income ratio. Your DTI is the total of all your other debts, divided by your monthly income. It includes your mortgage, home equity loans, car loans, credit card balances, student loans and lines of credit.