‘I find myself in a difficult situation where we’ve had to rely on credit cards’: I need to withdraw $75k from my 401k urgently. Roth or Non-Roth Non-Hardship & tax withholding?

Hi Money Minder,

How can I assist you with your financial queries today?

Let me cut to the chase: I’m in a bit of a financial pickle and really need some advice. I’m not a pro at retirement planning or investments; I’ve mainly focused on working, saving, and dreaming of a comfy retirement. But, thanks to some unexpected expenses and my daughter’s tuition, we’ve had to rely on credit cards to pay the bills. Now, I’m thinking about pulling out around $75k from my 401k to get us back on our feet since taking on more debt is just not an option.

I’m 53, so I’m getting close to the age where I can withdraw from my 401k without penalties. But, I can’t wait another 6 years! Here’s where I need your help:

Withdrawal Options: There are two withdrawal options available to me and I’m completely clueless about which one to pick. Any advice?
- Non-Roth Non-Hardship Withdrawal (has more funds available than Roth non-hardship)
- Roth Non-Hardship Withdrawal
Tax Withholding: We’re in the 32% income tax bracket. With a 10% early withdrawal penalty on top, should I withhold 32% or 42% from the withdrawal to cover the taxes?

Big thanks for helping out!

– Struggling Planners

Response from THE MONEY MINDER:

Hello There,

Hi there,

I’m sorry to hear about the financial challenges you’re facing. Retirement planning and managing debt can indeed be overwhelming, especially when unexpected expenses arise. It’s commendable that you’re taking proactive steps to address your situation.

Given your age and circumstances, it’s a crucial time to carefully consider your options. Withdrawing from your 401k early can indeed provide immediate relief, but you’ll want to balance that with the long-term impact on your retirement savings.

Regarding withdrawal options, here’s a detailed breakdown:

Non-Roth Non-Hardship Withdrawal: This option typically allows you to access a larger portion of your funds because it includes both your traditional 401k contributions and any employer matches. Keep in mind that the amount will be taxed as ordinary income when withdrawn, and due to your age, a 10% early withdrawal penalty will apply.

Roth Non-Hardship Withdrawal: Withdrawals from your Roth 401k contributions can be more advantageous since the principal you withdraw won’t be taxed, as you’ve already paid taxes on these contributions. However, earnings on those contributions would be subject to both income tax and the early withdrawal penalty unless you meet certain conditions.

Given that you’re in the 32% tax bracket, if you’re withdrawing from the Non-Roth account, you should plan for a combined withholding of approximately 42% to cover both the income tax and the early withdrawal penalty. This means, for a $75k withdrawal, you would need to set aside about $31,500 for taxes and penalties, leaving you with $43,500. While it’s tempting to reduce the withholding to 32%, this might leave you with a hefty tax bill come next April.

There’s also the possibility of taking a 401k loan if your plan allows it. This could mitigate taxes and penalties since you’re essentially borrowing from yourself and repaying within a specified period. The borrowed amount is not taxed or penalized if repaid according to the plan’s terms, although there are limits to how much you can borrow (typically 50% of your vested balance or up to $50k).

I recommend consulting with a financial advisor to help you weigh these options carefully. They can provide tailored advice based on your entire financial picture. Additionally, exploring other ways to reduce expenses or increase income temporarily could help lessen the amount you need to withdraw, thereby preserving more of your retirement savings.

Best of luck as you navigate this challenging time. With careful planning and the right advice, you can make informed decisions that support both your current situation and your future retirement goals.

Take care,
THE MONEY MINDER