Should You Take Money from Your 401(k) or Borrow from Your Parents When You're Unemployed?

When you're unemployed, out of savings, and your unemployment check doesn’t cover the bills, you may need another place to turn for money. Depending on your situation, you may be able to withdraw money from a 401(k) or ask your parents for a loan. While neither option is ideal, here are some considerations, including risks to keep in mind, to help you decide.

Withdrawing Money from 401(k) vs. Borrowing from Parents

In you are unemployed, you can withdraw money from your 401(k) but there are caveats. In general, withdrawals will be treated as distributions, so they will be subject to income taxes. If you are under 59½ you'll also pay an additional 10% penalty on the amount withdrawn, though there are a few exceptions.

The good news is that if you become unemployed in the year you turn 55 (or after), the funds in your 401(k) can be accessed without being subject to the 10% penalty. In other words, you don’t have to wait until you reach age 59½. Unfortunately, this does not apply to those who rolled over their 401(k) into an individual retirement account (IRA).

Another exception applies if you are under 55. You can access your funds without paying a penalty through what is called substantially equal periodic payments (SEPP). Under this arrangement, payments must be distributed over at least five years or until you reach 59½, whichever comes first.

Taking early withdrawals from your 401(k) can also put your long-term financial health at risk. The withdrawn funds miss out on long-term growth and the power of compounding.

“If the child is a responsible adult and has fallen on hard times, and this is not a recurring issue, then I would go to the parents for a loan and set up a payback plan in writing,” says Ashley M. Micciche, CEO, and retirement plan specialist with True North Retirement Advisors in Clackamas, Ore. “The long-term impact of a withdrawal from a retirement account is very damaging, especially when it’s someone in their 20s and 30s.”

However, you probably have more years to make up for lost ground than your parents. A loan isn’t necessarily a bad idea, but you should take it only if your parents or another loved one can afford it and you will repay the loan as agreed.

Withdrawing from Your 401(k)

If a 401(k) withdrawal is your best or only option, consider how you can minimize the financial damage from the lost investment opportunity and early withdrawal penalties.

First, keep taxes in mind. If you’ve already earned substantial income for the year, see if you can wait until next year to make a withdrawal. Try to limit your withdrawal to the minimum you will need to meet your essential living expenses for the rest of the year.

Second, consider alternative sources of funds. “If you have a Roth 401(k), you can take out your contributions—not the earnings on the investments—at any time without tax or penalty,” says Maggie Johndrow, a financial advisor with the Johndrow Wealth Group of Farmington River Financial in Farmington, Conn. Similarly, if you have a Roth IRA, you can withdraw contributions without penalty.

Third, keep the setback to your 401(k) balance in mind when job hunting. “I would suggest finding a job that has a 401(k) that includes a high employer 401(k) match. This may help rebuild retirement savings,” Johndrow says. Once you're working again, aim to contribute beyond the minimum required to get the employer match. Also consider funding an additional retirement account, such as an IRA, to offset some of the retirement savings you withdrew while unemployed.

Borrowing from Your Parents

Your parents might be willing to help you, but think twice before accepting their financial generosity.

“The most important thing to consider is where the money your parents are giving you is coming from,” says Misty Lynch, a financial consultant with John Hancock. “If they are wealthy and offer to help you out of cash flow or savings, that could be a good option, since any distribution you make from your 401(k) will be subject to taxes and penalties. You can repay them and start contributing to your retirement savings when you get back on your feet.”

However, try to avoid accepting money from your parents that is meant for their retirement.

“If they spend down their retirement assets, they might not have any time to build them back up," Lynch says. "Working into their 70s or 80s might be really difficult, and they might be forced to rely on you to help them out financially in the future." In these cases, it can be better to take the distribution from your own assets and make saving a priority when you start work again.

“The child should also pay interest to the parents, similar to what they would pay for borrowing from their 401(k),” says Ashley M. Micciche, CEO, and retirement plan specialist with True North Retirement Advisors in Clackamas, Ore. “Prime plus 2% is a good starting point.”

Other details, such as the repayment period and the amount of each monthly payment, should also be in writing, she says. The challenge is that the child may have no means of making loan payments right away.

“The best option here could be to allow the child to defer payments until they find employment, while the loan accrues interest—which should help incentivize the child to find work soon,” says Micciche.

The Bottom Line

You don’t want to take on expensive credit card debt. You can’t get a loan when you don’t have an income. So do you sacrifice your future and withdraw from the 401(k) plan you had at your last job? Or do you swallow your pride and ask Mom and Dad or another relative for a loan?

If you choose to withdraw from your 401(k), be prepared to pay income tax on the amount withdrawn. You may also be subject to a 10% early withdrawal penalty if you are under age 59½ and don't qualify for any exceptions. Also be sure to consider the long-term impact on your retirement savings.

If it makes more sense to take a loan from your parents or another loved one, make sure that they can truly afford it, there is a written agreement, and that you are able to pay it back consistently and on time.