What you should know to avoid making costly errors
Everyone would leave their homes in an ideal world of 401(k) funds alone until they need the money for retirement. That may entail transferring your account to an Individual Retirement Account (IRA). Still, it also entails not withdrawing funds before reaching retirement age in order to allow the money to grow to its full potential. When it comes to investing, time is truly your most valuable asset. You will, however, start taking distributions at some point, and here's what you need to know. The best way to withdraw funds from your 401(k) plan is determined by three factors:- What is your age?
- Whether or not you have a job with the company firm that sponsors your 401(k) plan
- The rules of your 401(k) plan
Important Takeaways
- If you withdraw money from your 401(k) before reaching the age of 59 1/2 and no longer work for your employer, you'll face a 10% tax penalty.
- If you're over a certain age, typically 59 1/2, and no longer employed, you can take a penalty-free 401(k) withdrawal.
- If you roll your 401(k) into an IRA, you'll avoid taxes and penalties, but you won't have access to the money because it must be a direct transfer.
- Check with your plan administrator to see if you can take a 401(k) loan rather than a withdrawal.
Taking money from a 401(k) (k) After You've Quit Your Job
If the company that sponsored your 401(k) plan no longer employs you, you should first contact your 401(k) plan administrator or the phone number listed on your 401(k) plan statement. Inquire about how to withdraw funds from the plan. You can't borrow money from your 401(k) or take a hardship withdrawal because you don't work there anymore. Either you must take a distribution or convert your 401(k) to an IRA. Any funds you withdraw from your 401(k) plan will fall into one of three categories, each with its own set of tax regulations.Withdrawal from a 401(k) on a regular basis
This is true if you are over the age of 59 1/2 and no longer work for the employer who sponsored the 401(k) plan (in some cases, you only need to be over the age of 55, as long as you were 55 or older at the time you retired from that employer). You'll have to pay income tax on the amount you withdraw from your 401(k), but there will be no penalty because of your age.Distribution from a 401(k) Plan at an Early Age
If you're under 59 1/2 years old or don't qualify for the age 55 regular withdrawal, and you're no longer employed by the company that sponsored the 401(k) plan, this applies to you. When you take money out of your 401(k) plan early, you will be subject to income taxes as well as a 10% penalty. Think twice if you need to cash out your 401(k) plan early due to debt or other financial difficulties. Even if you declare bankruptcy under Chapter 7, your 401(k) assets will be safe from creditors.401(k) to IRA Rollover
Your 401(k) account balance can be rolled over to an IRA at any company of your choice. If you transfer your funds to an IRA, you won't pay any taxes, and your money will stay in your IRA for future use. Then you can only take money out of your IRA as needed. You only have to pay taxes on the money you take out. You can also use a special rule known as 72(t) payments with an IRA, which allows you to take money out while avoiding the early-withdrawal penalty. Depending on your situation and how you intend to use your withdrawn funds, the penalty has some exceptions.When You're Still Working, You Can Take Cash Out
Some 401(k) plans prohibit you from withdrawing funds while still employed by your company. A 401(k) loan, a hardship withdrawal, or an in-service distribution are some of the options available in other plans.Loan from your 401(k)
Many 401(k) plans offer a 401(k) loan, which allows you to borrow against your account balance. The maximum loan amount is usually $50,000 or half of your vested 401(k) account balance, whichever is lower. You will be charged interest, and the money will not earn interest while it is out of the account, so only use this option in an emergency.Hardship Withdrawal from a 401(k)
If your situation falls under the hardship exceptions, some, but not all, 401(k) plans allow you to take a hardship withdrawal.Distribution in-service
This option is available in a few 401(k) plans that allow you to withdraw money from the plan while still employed. Note: In all of the above cases, contact your 401(k) plan administrator or call the number listed on your 401(k) plan statement to see if these options are available.What Happens if You're a 401(k) Plan Beneficiary?
When it comes to taking money out of a 401(k) plan, you will be subject to a slightly different set of rules if you are the Beneficiary. Your options will be determined by whether you were the spouse or non-spouse of the 401(k) plan participant, as well as whether the 401(k) plan participant had reached the mandatory minimum distribution age of 70 1/2. (RMD). Important: If you or your spouse turned 70 1/2 before January 1, 2020, you or your spouse are still eligible for RMDs. RMDs must be taken at the age of 72 if you or your spouse turned 70 1/2 on or after January 1, 2020.Final Thoughts
Taking money out of a 401(k) plan means you're taking money out of a fund that was set aside and invested for your future retirement. Consider your other financial options, such as your emergency fund, a personal loan, or a home equity loan, for additional funds. Consider consulting with a financial advisor to better understand how withdrawing funds from your 401(k) will affect your overall financial situation.Most Commonly Asked Questions (FAQs)
What are the consequences of prematurely withdrawing funds from a 401(k)?
If you withdraw money from your 401(k) before turning 59 1/2, you'll have to pay a 10% penalty on top of regular income taxes on the distribution.How long do I have to roll the money over from my 401(k) if I take money out?
To avoid paying the penalty, you must deposit a distribution directly into an IRA within 60 days of receiving it.I'm not sure why I'm being told I have to withdraw funds from my 401(k)?
Required minimum distributions (RMDs) start at a certain age in retirement plans, including your 401(k). RMDs are already required if you turn 70 1/2 prior January 1, 2020. RMDs are not required until the age of 72 for taxpayers who turn 70 1/2 on or after January 1, 2020.