The Expert Podcast

For most people, a 401k fund is the biggest financial asset they have outside of their primary residence or their home. Many people have tens of thousands, sometimes hundreds of thousands, in a 401k, and in some cases, over a million dollars. This may represent the vast majority of their holdings, and in some cases, the largest percentage of their liquid holdings, meaning money that is easy to access. Look, your primary residence or real estate may have equity, and it may be your largest asset on paper for your personal net worth. However, it's not easy to access that money. Sure, you can get a home equity loan or a line of credit, but that may not be the primary way to go.

A 401k fund has ways you can withdraw from it without actually cashing it out. Some of those withdrawal methods have penalties, where you have to pay a fine for taking it out early. There are some ways you can withdraw from it without a penalty. For example, if you have unreimbursed medical bills that you need to pay for, you can normally take money out from your 401k fund without paying a penalty. Similarly, if you have a disability and need to pay expenses, you can normally take money from your 401k without having a penalty.

Now, remember, a penalty is different from taxes. If you don’t pay a penalty, that’s fine, but you may have to pay taxes on it. When you put that money in, you avoided income tax on it, so you may be taxed on your withdrawal. You may also be able to make a withdrawal to pay for health insurance if needed. Remember, no penalty, but you probably have to pay taxes.

If you have a 401k holder who is deceased, the beneficiaries can normally take withdrawals without paying the 10% penalty, but you have to pay the tax. So, you see where all this is going—there's a very common theme: death or medical-related withdrawals may avoid penalties, but you do have to pay taxes.

A couple of other exceptions that are not related to medical conditions are if you have back taxes or a tax lien, or if you owe money to the IRS for your taxes. You can normally take money from your 401k to pay that. The bottom line is that if you don't take the money out, they’re going to take it anyway, so you might as well pay it.

If you're a first-time homeowner and you want to use your 401k funds as a down payment, you can take money out. However, that may still trigger a 10% penalty if it's a 401k but not an IRA. Some college expenses may be exempt. And if you are an investor and want to take some profit out, you may be able to do that through normal disbursements.

A 401k is an extremely valuable wealth creation tool, just like your primary residence or other real estate, but you have to manage it carefully so you don’t have to take money out before you need it. If you run into a hardship and have to remove money from that fund, you may lose tax benefits, lose investment value, and in some cases, pay a penalty.