Early 401(k) Withdrawals Without Penalty


You work hard to save money in your retirement accounts, so it is best not to waste any of it by incurring withdrawal penalties when you want to use it. Here is what you need to know to withdraw money from your 401(k) without penalty.

You work hard to save money in your retirement accounts, so it is best not to waste any of it by incurring withdrawal penalties when you want to use it. Here is what you need to know to withdraw money from your 401(k) without penalty.If you don’t meet the minimum age and other requirements for withdrawing funds from your 401(k), you could face a hefty 10 percent early withdrawal penalty. That’s not all — you could also be subject to paying income tax on the funds you withdraw.

“If you’re in a high tax bracket, you could end up paying 50 percent or more of your withdrawal amount in taxes and penalties,” according to Financial Writer Matthew Frankel of Motley Fool, a multimedia financial services company. “And, while taxes aren’t avoidable unless you have a Roth 401(k), there are some instances in which you could avoid paying the 401(k) early withdrawal penalty.”

One way that you can withdraw funds from your 401(k) before the age of 59 1/2 without a penalty is by ceasing to work during or after the calendar year when you will turn 55. This is known as “separation from service.”

“Also keep this rule in mind when deciding whether to roll money over from a 401(k) to an IRA after you leave your job,” states the “Ask Kim” Columnist for Kiplinger. “If you leave your job at age 55 or older but then roll the 401(k) over to a traditional IRA, you’ll generally have to wait until age 59½ to tap the money without penalty. (There are a handful of exceptions that allow penalty-free IRA withdrawals, such as using the money to pay for health insurance when unemployed or using up to $10,000 for a first-time home purchase.)”

It is also possible to avoid penalties if you agree to take your distributions in “substantially equal payments.” The series of payments must be spread over a minimum of five years or as many years as it takes for you to reach the age of 59 1/2, depending on which time period is longer.

If you are divorced and a domestic relations order gives a portion of your 401(k) to your ex-spouse, you will not be penalized on that withdrawal. In other words, you can use your 401(k) assets to meet a divorce settlement without facing a penalty.

“Since a 401(k) early withdrawal penalty goes to the IRS anyway, they are nice enough to waive the penalty if you withdraw from your account to cover unpaid taxes,” according to Frankel.

There are also certain health-related circumstances that allow you to tap in to your 401(k) without paying a penalty, regardless of your age. One of these is permanent disability. Also, if you have unreimbursed medical expenses that are more than 10 percent of your adjusted gross income in a certain year, you are permitted to pay for them with your 401(k) assets.

If you are a reservist who is called in to active duty, you may also meet the qualifications to withdraw funds without penalty. This is only possible if your active duty is for 180 days or longer.

Lastly, regulations that allow people to roll money from their 401(k) accounts into other qualified retirement plans allow them 60 days to do so. This means that if you return the money to a qualified account during those 60 days, you will not be penalized, making it a potential source for an interest-free short-term loan.

Keep in mind that taking money from your retirement accounts should be a last resort. Even if you pay back a similar amount later on, your account will miss out on the compounding interest that could have grown had the funds stayed in the account the whole time. The best way to determine whether it is possible or advisable to withdraw funds from your 401(k) is to talk to your financial adviser.

 

Related Articles

Leave a Reply