Rules About Early 401 Withdrawals
Should you make a 401 withdrawal before you reach age 59.5, the IRS will consider it an early distribution. This will induce a 10% tax penalty on it. In addition, because you have yet to pay any taxes on the money, youll owe income taxes. As you can imagine, this is a pretty dangerous way to withdraw funds from your 401.
That said, the IRS allows for penalty-free hardship withdrawals. To qualify for one, youll need to demonstrate what the IRS calls an immediate and heavy need. On top of this, you must prove that there are no other assets that could satisfy that need, such as a vacation home.
Examples of hardships that can earn you an exemption from the 10% withdrawal penalty include:
- Housing payments needed to prevent eviction
- Certain home repair expenses for a primary residence
It should be noted, though, that its up to your plan to allow for hardship withdrawals. The IRS doesnt require them. It only delineates the circumstances under which they may happen. Also, you should know that though you wont have to pay the 10% penalty, you will still have to pay income taxes on the distribution.
Take An Early Withdrawal
Perhaps youre met with an unplanned expense or an investment opportunity outside of your retirement plan. Whatever the reason for needing the money, withdrawing from your 401 before age 59.5 is an option, but consider it a last resort. Thats because early withdrawals incur a 10% penalty on top of normal income taxes.
While an early withdrawal will cost you an extra 10%, it will also diminish your 401s future returns. Consider the consequences of a 30-year-old withdrawing just $5,000 from his 401. Had the money been left in the account, it alone would have been worth over $33,000 by the time he turns 60. By withdrawing it early, the investor would forfeit the compound interest the money would accumulate in the years that follow.
What Are The Pros And Cons Of Withdrawal Vs A 401 Loan
A withdrawal is a permanent hit to your retirement savings. By pulling out money early, youll miss out on the long-term growth that a larger sum of money in your 401 would have yielded.
Though you wont have to pay the money back, you will have to pay the income taxes due, along with a 10% penalty if the money does not meet the IRS rules for a hardship or an exception.
A loan against your 401 has to be paid back. If it is paid back in a timely manner, you at least wont lose much of that long-term growth in your retirement account.
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What Are The Pros And Cons Of Withdrawal Vs A 401k Loan
|Pros and Cons of 401k Withdrawal vs. 401k Loan|
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Is It A Good Idea To Borrow From Your 401
Using a 401 loan for elective expenses like entertainment or gifts isn’t a healthy habit. In most cases, it would be better to leave your retirement savings fully invested and find another source of cash.
On the flip side of what’s been discussed so far, borrowing from your 401 might be beneficial long-termand could even help your overall finances. For example, using a 401 loan to pay off high-interest debt, like credit cards, could reduce the amount you pay in interest to lenders. What’s more, 401 loans don’t require a credit check, and they don’t show up as debt on your credit report.
Another potentially positive way to use a 401 loan is to fund major home improvement projects that raise the value of your property enough to offset the fact that you are paying the loan back with after-tax money, as well as any foregone retirement savings.
If you decide a 401 loan is right for you, here are some helpful tips:
- Pay it off on time and in full
- Avoid borrowing more than you need or too many times
- Continue saving for retirement
It might be tempting to reduce or pause your contributions while you’re paying off your loan, but keeping up with your regular contributions is essential to keeping your retirement strategy on track.
Long-term impact of taking $15,000 from a $38,000 account balance
The Rules For Accessing Your Money Are Determined By Your Employer’s Plan
Whether you can take regular withdrawals from your 401 plan when you retire depends on the rules for your employers plan. Two-thirds of large 401 plans allow retired participants to withdraw money in regularly scheduled installments — say, monthly or quarterly. About the same percentage of large plans allow retirees to take partial withdrawals whenever they want, according to the Plan Sponsor Council of America , a trade association for employer-sponsored retirement plans.
Other plans offer just two options: Leave the money in the plan without regular withdrawals, or take the entire amount in a lump sum. ‘s summary plan description, which lays out the rules, or call your company’s human resources office.) If those are your only choices, your best course is to roll your 401 into an IRA. That way, you won’t have to pay taxes on the money until you start taking withdrawals, and you can take money out whenever you need it or set up a regular schedule.
If your company’s 401 allows periodic withdrawals, ask about transaction fees, particularly if you plan to withdraw money frequently. About one-third of all 401 plans charge retired participants a transaction fee, averaging $52 per withdrawal, according to the PSCA.
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Withdrawing Money From A 401 After Retirement
Once you have retired, you will no longer contribute to the 401 plan, and the plan administrator is required to maintain the account if it has more than a $5000 balance. If the account has less than $5000, it will trigger a lump-sum distribution, and the plan administrator will mail you a check with your full 401 balance minus 20% withholding tax.
Before you can start taking distributions, you should contact the plan administrator about the specific rules of the 401 plan. The plan sponsor must get your consent before initiating the distribution of your retirement savings. In some 401 plans, the plan administrator may require the consent of your spouse before sending a distribution. You can choose to receive non-periodic or periodic distributions from the 401 plan.
For required minimum distributions, the plan administrator calculates the amount of distribution for the qualified plans in each calendar year. The 401 may provide that you either receive the entire benefits in the 401 by the required beginning date or receive periodic distributions from the required date in amounts calculated to distribute the entire benefits over your life expectancy.
Dividing Your 401 Assets
If you divorce, your former spouse may be entitled to some of the assets in your 401 account or to a portion of the actual account. That depends on where you live, as the laws governing marital property differ from state to state.
In community property states, you and your former spouse generally divide the value of your accounts equally. In the other states, assets are typically divided equitably rather than equally. That means that the division of your assets might not necessarily be a 50/50 split. In some cases, the partner who has the larger income will receive a larger share.
For your former spouse to get a share of your 401, his or her attorney will ask the court to issue a Qualified Domestic Relations Order . It instructs your plan administrator to create two subaccounts, one that you control and the other that your former spouse controls. In effect, that makes you both participants in the plan. Though your spouse cant make additional contributions, he or she may be able to change the way the assets are allocated.
Your plan administrator has 18 months to rule on the validity of the QDRO, and your spouses attorney may ask that you not be allowed to borrow from your plan, withdraw the assets or roll them into an IRA before that ruling is final. Once the division is final, your former spouse may choose to take the money in cash, roll it into an IRA or leave the assets in the plan.
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Series Of Substantially Equal Payments
If none of the above exceptions fit your individual circumstances, you can begin taking distributions from your IRA or 401k without penalty at any age before 59 ½ by taking a 72t early distribution. This allows you to take a series of specified payments every year. The amount of these payments is based on a calculation involving your current age and the size of your retirement account.
The catch is that once you start, you have to continue taking the periodic payments for five years, or until you reach age 59 ½, whichever is longer. Also, you will not be allowed to take more or less than the calculated distribution, even if you no longer need the money. So be careful with this one!
Pay Attention To Required Minimum Distributions
According to federal tax rules, you must start taking minimum distributions from tax-deferred retirement savings accounts including 401s, 403s, 457s, traditional IRAs and SEP IRAs by April 1 after the year you reach age 72. Failure to do so will result in a penalty charge that can be as high as 50% of the distribution amount. Here are some of the key things to remember about RMDs:
- The amount that you must take out each year depends on your age, life expectancy and year-end account balance. You may take out more than the minimum.
- If you have multiple retirement accounts, you must calculate RMDs separately, but you can withdraw the total amount from one or many accounts.
- Roth IRAs and most non-qualified employee-sponsored plans do not require RMDs.
- You cant rollover RMDs into another type of tax-advantaged account.
- If you are still working at 72, you can continue contributing to your traditional 401 or 403 or Roth 401 or 403. You don’t need to take an RMD until you separate from service. However, you will be required to take RMDs from any IRA you may own even if you are still working at 72.
While you are responsible for taking distributions from your account, your retirement plan administrator may be able to help by making RMDs automatic. At TIAA, we offer the Minimum Distribution Option, which calculates and pays out RMDs automatically, helping you satisfy federal requirements while preserving your account balance.
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Withdrawals Before Age 59 1/2
Any withdrawal made from your 401 will be treated as taxable income and subject to income taxes in the year in which you made it, before or after retirement. But youll also be subject to a 10% early distribution penalty if youre younger than age 59 1/2 at the time you take the withdrawal.
These taxes and penalties can add up and can nearly cut the value of your original withdrawal in half in some cases.
You can avoid these taxes and the penalty with a trustee-to-trustee transfer. This involves rolling over some or all of your 401 assets into another qualified account. You might consider a 401 loan if you want to access your accounts assets because of financial hardship.
You can take a penalty-free withdrawal from your 401 before reaching age 59 1/2 for a few reasons, however:
- You pass away, and the accounts balance is withdrawn by your beneficiary.
- You become disabled.
- Your unreimbursed medical expenses are more than 7.5% of your adjusted gross income for the year.
- You begin substantially equal periodic withdrawals.
- Your withdrawal is the result of a Qualified Domestic Relations Order after a divorce.
- Youre at least 55 years old and have been laid off, fired, or quit your job, otherwise known as the Rule of 55.
Your distributions will still be taxed if you take the money for any of these reasons, but at least youll dodge the extra 10% penalty.
Planning Out The Timing Of Your Withdrawals
The timing of your early withdrawals is important, says Dave Lowell, certified financial planner and founder of Up Your Money Game.
If you were employed for most of the year and had a relatively high income, then it makes sense to not withdraw money under the rule of 55 in that calendar year, since it will add to your total income for the year and possibly result in you moving to a higher marginal tax bracket, Lowell says.
The better strategy in that scenario may be to use other savings or take withdrawals from after-tax investments until the next calendar rolls around. This may result in your taxable income being much lower.
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Keeping Your Money In A 401
You are not required to take distributions from your account as soon as you retire. While you cannot continue to contribute to a 401 held by a previous employer, your plan administrator is required to maintain your plan if you have more than $5,000 invested. Anything less than $5,000 will likely trigger a lump-sum distribution.
If you have no need for your savings immediately after retirement, then theres no reason not to let your savings continue to earn investment income. As long as you do not take any distributions from your 401, you are not subject to any taxation.
If your account has $1,000 to $5,000, your company is required to roll over the funds into an IRA if it forces you out of the planunless you opt to receive a lump-sum payment or roll over the funds into an IRA of your choice.
How To Withdraw Money From A 401k After Retirement
During your working years, you’ve probably set aside funds in retirement accounts such as IRAs, 401s, or other workplace savings plans. Your challenge during retirement is to convert those accounts into an income stream that can continue to provide adequately throughout your retirement years.
If youre approaching the age that you want to hang your hat from working, you may be wondering how to withdraw money from your 401 after retirement. It isnt always exactly straightforward, which is why weve broken down some of the basics of using your 401. Heres what you need to know.
Home Equity Loan Or Heloc
If you own a home with equity built up, a home equity loan or home equity line of credit can be a low-interest alternative to a personal loan. This type of loan is often referred to as a second mortgage because the loan is secured by your home. In other words, if you default on the loan, your lender may have a right to foreclose on your home.
One of the major benefits of a home equity loan or HELOC over a personal loan is the interest rate. Loans that are secured by homes including mortgages, home equity loans, and HELOCs often have some of the lowest interest rates on the market. As a result, the loan will cost you less money over the long term.
Its important to proceed with caution if youre considering a home equity loan or HELOC. As we mentioned, these loans are secured by your home. If you cant make your monthly payments, you risk having the lender take your home. As a result, you should avoid this option if you think for any reason you may not be able to repay the loan on time.
Retire With Peace Of Mind
Your withdrawal strategy matters in retirement. It can mean the difference between having funds to last you for the rest of your life or falling short. Its always best to research your options thoroughly and speak to a financial advisor to come up with a plan that works for you.
* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. , a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.
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