Is it ever OK to raid your 401(k)?

Is it ever OK to raid your 401(k) before you reach retirement age?

It's almost never a good idea to withdraw money from a 401(k) plan early. The costs of dipping into that fund before it matures can set the stage for later retirement -- or no retirement at all.

For that reason, most 401(k) accounts have a series of penalties in place to make it extremely difficult to take out money early: Employers want you to leave the balance untouched as long as possible, allowing it to grow so that you can benefit from it in retirement. But despite built-in disincentives, more than one-third of 401(k) participants dipped into their retirement early, according to a major study, often to cover surprise expenses.

Here are some factors to weigh if you find yourself in that situation.

Taxes and penalties

Any money withdrawn from a 401(k) plan is taxed at your regular income rate. Withdrawing before the IRS-mandated age of "59½"  usually means that money is subject to an additional 10 percent of the withdrawal value as a penalty for taking it out early. All this can add up fast: for example, if you want to take $15,000 out of your account, you could be working with only $10,000 after taxes and penalties.

"The best thing you can come up with there is it being the lesser of two or more evils, but those would have to be pretty evil evils," Bankrate's chief financial analyst Greg McBride told CBS MoneyWatch. "No matter how you slice it, it is a permanent setback to your retirement plan. You lose the tax efficiency, you pay a penalty, and you can't put the money back in later," he said. 

Taking a loan

In rare cases, like paying off high interest rate credit cards or student debt, borrowing from your 401(k) could be an option. For most plans, it is possible to take a loan of up to half the balance, at a maximum amount of $50,000. Unlike a withdrawal, loans are not subject to tax since they will be paid back.

This kind of financial maneuvering only makes sense under certain circumstances, like when the rate of return on a 401(k) loan is significantly lower than the rate on a person's other debt -- and if their salary is high enough to make the monthly 401(k) loan payments, according to Helen Ngo, a founder of Capital Benchmark Partners in Atlanta.

"The trick is this is not a strategy that works for everybody that they are making large enough lump sum payments on the cards."

It is important to keep in mind whether or not the monthly payments on that loan are within budget. Missing just one monthly payment on a 401(k) loan will make the full amount borrowed subject to tax penalties.  Also, if you change jobs or get fired, you must pay back the loan immediately, in its entirety. In general, a 401(k) loan must be repaid within five years, unless it is used to buy your home.

"Most employers will factor in repayment in your paycheck. If you leave that company or if you're fired, you have to pay back the full balance of the loan within 60 days," Entelechy CEO Ben Brown told CBS MoneyWatch. If you can't pay it off in that time, it's considered a withdrawal -- with all the attendant penalties. "You're in big trouble, because then it's fully taxable, and you have to pay the 10 percent penalty if you're under 55," Brown said.

Need the cash

If you are in dire financial need, many 401(k) plans allow "hardship withdrawals" which can be used to cover sudden medical bills or tuition payments. But the need has to be demonstrated as immediate and heavy, with no alternative to satisfy the payment.

Unlike loans, hardship withdrawals do not have to be paid back, and there may be some rules regarding when you can contribute into a retirement plan after hardship.  

Rebuilding savings is difficult since there are limits to how much a person may contribute to a 401k annually. Before age 50, the limit is $18,000 per year. Savers over 50 are allowed an additional catch-up contribution of up to $6,000 per year. Since a 401(k) allows earnings to compound tax-free, withdrawing funds early may result in future contributions accumulating at a slower rate.