Hurricane Victims: Is It a Good Idea to Take a Hardship Loan from Your 401(K) to Get Cash?

Home with extreme damageTo help the victims of the most recent hurricanes, the IRS has decided to relax some of its rules, which would allow these victims to take out hardship loans against their 401(k) retirement accounts. Although having this money may help you to replace some of your possessions, it may not be the best course of action for everyone.

About Hardship Loans

When you take out a hardship loan against your 401(k), it isn't taxable as long as you pay the debt back within the specified term. In most cases, the term will be five years. In addition, this type of loan doesn't require a credit check, and it isn't nearly as expensive as using a credit card to cover the costs of rebuilding and/or replacing your possessions.

However, it is important to note that a hardship loan isn't without risks. If you leave your current employer before the loan has been repaid, you must pay the remaining balance within 60 to 90 days. For many borrowers, this would be difficult or impossible.

Disadvantages of Hardship Distributions

Hardship distributions are different from hardship loans, and taking out a hardship distribution has a significant effect on your financial future. Although Congress may eliminate the 10 percent penalty on early withdrawals for hurricane victims under age 59 1/2, the distribution won't be exempt from ordinary income tax. In addition, the total amount of money in your 401(k) drops as soon as you take out a distribution, which reduces the income the account earns in the future.

Other Options

Hardship loans and hardship distributions aren't the only options for hurricane victims who need extra money. Some of the other options you could consider include:

  • Home equity line of credit- Although you won't be able to use this option if your home is damaged, a home equity line of credit could be used to pay for other types of damage or loss, as well as to help a relative affected by one of the hurricanes.
  • Selling other investments- If you own other investments, such as stock or bonds, cashing them out can help you pay for repairs without facing any penalties. However, selling these assets will affect your income taxes.
  • Small Business Administration loans- If you have a damaged home in a federal disaster loan, you may be eligible for an SBA long-term SBA loan with a low interest rate.
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