Taking Premature Distributions
Thus far, I’ve focused on mistakes associated with not saving enough. But sometimes, life throws you little curveballs and you find yourself with larger-than-expected medical bills or some other kind of emergency.
Should that happen to you, you should move heaven and earth before you take a premature distribution from your 401k plan. In addition to income taxes you would owe, you’ll also get slapped with a 10% early withdrawal penalty. By the time the penalties and taxes are paid, there isn’t likely to be a lot left to pay for your emergency.
I’m naturally averse to debt. But as a general rule, I think it’s far better to borrow to cover an emergency expense than to dip into your 401k, particularly given how low interest rates are today.
And, while I hope it would never come to this, it’s worth remembering that 401k funds are generally safe from creditors in the event of bankruptcy. If I were to ever have crippling expenses that pushed me to the point of insolvency, I’d prefer to default on my debts and sort it out in bankruptcy count while leaving my 401k balances intact.