Can I Withdraw From My 401 At 55 Without A Penalty
If you leave your job at age 55 or older and want to access your 401 funds, the Rule of 55 allows you to do so without penalty. Whether you’ve been laid off, fired or simply quit doesn’t matteronly the timing does. Per the IRS rule, you must leave your employer in the calendar year you turn 55 or later to get a penalty-free distribution. So, for example, if you lost your job before the eligible age, you would not be able to withdraw from that employer’s 401 early you’d need to wait until you turned 59½.
It’s also important to remember that while you can avoid the 10% penalty, the rule doesn’t free you from your IRS obligations. Distributions from your 401 are considered income and are subject to federal taxes.
Build An Emergency Fund
This should be the foundation of your financial plan and experts recommend having about six months worth of expenses saved. You can park this money in a high-yield savings account to earn more interest than you would in a traditional checking account. An emergency fund should help you manage most of lifes curveballs.
If You Dont Qualify Through The Cares Act
If you dont qualify for special accommodation through the CARES Act, then you will have to pay a 10% penalty on withdrawals from your 401 as well as income taxes on amounts you take out. With a traditional 401 loan, on the other hand, you may be limited to borrowing just 50% of your vested funds or $50,000, whichever is less.
However, you should note that the IRS extends other hardship distribution categories you may qualify for if youre struggling financially . You can read about all applicable hardship distribution requirements on the IRS website.
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Request A Hardship Withdrawal
In certain circumstances you may qualify for whats known as a hardship withdrawal and avoid paying the 10% early distribution tax. While the IRS defines a hardship as an immediate and heavy financial need, your 401 plan will ultimately decide whether you are eligible for a hardship withdrawal and not all plans will offer one. According to the IRS, you may qualify for a hardship withdrawal to pay for the following:
- Medical care for yourself, your spouse, dependents or a beneficiary
- Costs directly related to the purchase of your principal residence
- Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for you, your spouse, children, dependents or beneficiary
- Payments necessary to prevent eviction from your principal residence or foreclosure on the mortgage on that home
- Funeral expenses for you, your spouse, children or dependents
- Some expenses to repair damage to your primary residence
Although a hardship withdrawal is exempt from the 10% penalty, income tax is owed on these distributions. The amount withdrawn from a 401 is also limited to what is necessary to satisfy the need. In other words, if you have $5,000 in medical bills to pay, you may not withdraw $30,000 from your 401 and use the difference to buy a boat. You might also be required to prove that you cannot reasonably obtain the funds from another source.
If You’re Still Working For The Company
Most 401 plans don’t allow “regular withdrawals” at age 55 while you’re still working for the company. A regular withdrawal is defined as one that’s not subject to penalties and doesn’t require you to qualify based on special circumstances.
You might be able to take a 401 loan or qualify for a hardship withdrawal rather than take a regular withdrawal if your 401 plan allows these options. Not all 401 plans are required to offer loans or hardship withdrawals, however.
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What Are The Penalty
The Internal Revenue Service permits withdrawals without a penalty for certain specific uses, including to cover college tuition and to pay the down payment on a first home. It terms these exceptions, but they also are exemptions from the penalty it imposes on most early withdrawals.
It also allows hardship withdrawals to cover an immediate and pressing need.
There is currently one more permissible hardship withdrawal: for costs directly related to the COVID-19 pandemic.
Youll still owe regular income taxes on the money withdrawn, but you wont get slapped with the 10% early withdrawal penalty.
Alternatives To Taking Money From Your 401
There may be some situations where taking money out of your 401 makes sense, including instances where you have no other option but to access this money to keep the lights on and food on the table. If you cash out your 401 and the market tanks afterward, you could even wind up feeling like a genius. Then again, the chances of optimally timing your 401 withdrawal are extremely slim.
With that being said, if you dont have to take money out of your 401 plan or a similar retirement plan, you shouldnt do it. You will absolutely want to retire one day, so leaving the money youve already saved to grow and compound is always going to leave you ahead in the long run.
With that in mind, you should consider some of the alternatives of taking money from a 401 plan:
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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.
Can You Roll Your 401 Into A Roth 401
You may be able to convert your 401 into a Roth 401 if your employer offers it. There can be good reasons to do this, the biggest being that you wont have to pay taxes on withdrawals. However, you will have to pay income taxes on the amount you convert. To cover the taxes, youll need to set this cash aside, outside of your retirement account.
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Taking 401 Distributions In Retirement
The 401 withdrawal rules require you to begin depleting your 401 savings when you reach age 72.
At this point, you must take a required minimum distribution each year until your account is depleted. If you are still working for the employer beyond age 72, you may be able to delay required minimum distribution until you stop working if your plan allows this delay. The delay option is not available to you if you own 5% or more of the business.
You have until April 1 of the year after you turn 72 to take your first required minimum distribution. After that, you must take a minimum amount by December 31 each year. Your 401 plan administrator will tell you how much you are required to take each year.
The amount is based on your life expectancy and your account balance. If you dont take your required minimum distribution each year, you will have to pay a tax of 50% of the amount that should have been taken but was not. If you participate in more than one employer plan, you must take a required minimum distribution from each plan.
Withdrawal Penalty Before Age 59
If you’re under age 59½, you may have to pay an additional 10% when you file your tax return. If you are still working when you are 59 ½, you can take money out of your 401.
You can take money from your 401 account if you are age 59½ or older. You will not have a penalty. Twenty percent is withheld for federal income taxes. You can also roll money from your 401 to IRA or other qualified plan. Funds that are rolled over are not subject to tax at that time.
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Hardships Early Withdrawals And Loans
Generally, a retirement plan can distribute benefits only when certain events occur. Your summary plan description should clearly state when a distribution can be made. The plan document and summary description must also state whether the plan allows hardship distributions, early withdrawals or loans from your plan account.
When You Can Borrow
Once you pull money out of your plan, those dollars no longer benefit from long-term market returns.
If you have a pool of emergency funds, it’s best to use that money first. If you’re managing debt, it’s even better to build that repayment into your budget.
Even your boss wants you to keep your hands off your retirement plan savings.
That said, here are three extreme cases that may warrant a 401 loan.
You have an immediate emergency.“Say that you need to meet the deductible on your high-deductible health-care plan, and you have no money in your health savings account,” said Aaron Pottichen, president of retirement services at CLS Partners in Austin, Texas.
He is referring to the tax-advantaged health savings account that individuals may use to cover qualified medical expenses. It’s also known as an HSA.
You have an urgent cash need, but your credit precludes you from obtaining a competitive interest rate. Ask yourself what you can repay in five years.
You need to pay off high-interest debt that’s hampering your long-term financial goals. This is the case if the interest rate on your 401 is lower than what your creditor is offering you.
“If you’re in ‘pay down debt mode,’ it’s all about what’s your cheapest interest rate and how fast can you get the debt down,” said Pottichen.
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Does This Plan Really Make Sense In The Long Term
PMI typically costs about 0.5% to 1.5% of the loan amount, annually. On a $250,000 home loan, a 1% PMI premium would add $2,500 a year or about $208 a month to your mortgage payment.
Yes, thats a lot of money. But PMI also has a great return on investment. Considering the equity youll build through homeownership, you could see a return on investment of over 500% all while leaving your retirement savings account untouched.
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What Type Of Situation Qualifies As A Hardship
The following limited number of situations rise to the level of hardship, as defined by Congress:
- Unreimbursed medical expenses for you, your spouse or dependents
- Payments necessary to prevent eviction from your home or foreclosure on a mortgage of principal residence.
- Funeral or burial expenses for a parent, spouse, child or other dependent
- Purchase of a principal residence or to pay for certain expenses for the repair of damage to a principal residence
- Payment of college tuition and related educational costs for the next 12 months for you, your spouse, dependents or non-dependent children
Your plan may or may not limit withdrawals to the employee contributions only. Some plans exclude income earned and or employer matching contributions from being part of a hardship withdrawal.
In addition, IRS rules state that you can only withdraw what you need to cover your hardship situation, though the total amount requestedmay include any amounts necessary to pay federal, state or local income taxes or penalties reasonably anticipated to result from the distribution.
A 401 plan even if it allows for hardship withdrawals can require that the employee exhaust all other financial resources, including the availability of 401 loans, before permitting a hardship withdrawal, says Paul Porretta, a compensation and benefits attorney at Troutman Pepper in New York.
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Why Nitzsche Used His 401 To Pay Off Credit Card Debt
Nitzsche speaks from experience. He is 40 now and a self-proclaimed “credit junkie” with a credit score over 800, but in 2008 when he was in his twenties and laid off from his job, he was burdened with having to pay a mortgage on a new home, just over $20,000 in student loans and over $10,000 in credit card debt.
He made some lifestyle changes, such as having three others live in his St. Louis, MO, home at the time to split mortgage and utility payments. But one of the biggest decisions he made was completely tapping into his retirement savings what he estimates was about $20,000 at the time to pay off his credit cards. Nitzsche tells Select that it was a decision he likely would not make again.
“That decision was largely done out of just panic and prioritizing,” Nitzsche says. “I knew that I wanted to do everything possible to stay in good shape to keep my home because I had just bought it a year before and obviously had a lot of pride in home ownership.”
But now that over ten years have passed, Nitzsche is still feeling the effects of his decision, and he’s not sure he would encourage someone in a similar scenario to do what he did.
Do You Have To Pay Taxes On An Ira After 70
All of the money in your traditional IRA belongs to you. … You must begin taking minimum withdrawals from your traditional IRA in the year you turn age 70 1/2. The amount you withdraw at that time is taxed as ordinary income, but the funds that remain in your IRA continue to grow tax deferred regardless of your age.
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How Long Does It Take To Cash Out A 401
While the amount of time it takes to receive money differs by plan, administrator and employer, you can often expect to wait several weeks minimum to receive your funds. Some plans may also be bound by rules that prohibit them from distributing these funds more than once a quarter or year, extending this time horizon to 30 90 days or more.
As 401 plans are highly regulated, and subject to strict governance, it can often take a considerable amount of time to ensure that proper guidelines are followed. Complete paperwork must also be in hand in order for requests to process. Noting that any funds withdrawn are unlikely to become immediately available, be sure to consult your summary plan description document to learn more about the rules of your plan, and how long it can take to receive disbursements.
Withdrawal Rules Frequently Asked Questions
If you participate in a 401 plan, you should understand the rules around separation of service, and the rules for withdrawing money from your account otherwise known as taking a withdrawal. 401 plans have restrictive withdrawal rules that are tied to your age and employment status. If you dont understand your plans rules, or misinterpret them, you can pay unnecessary taxes or miss withdrawal opportunities.
We get a lot of questions about 401 withdrawal rules from participants. Below is a FAQ with answers to the most common questions we receive. If you are a 401 participant, you can use our FAQ to understand when you can take a withdrawal from your account and how to avoid penalties.
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What Happens To My 401 If I Quit My Job
When you leave a job, you have several options for what to do with your 401.
You can cash it out, leave it with your old employer, or roll it into an IRA. Each option has different tax implications, so choosing the one thats best for your situation is important.
If you cash out your 401, youll have to pay taxes on the amount you withdraw. You may also be subject to a 10% early withdrawal penalty if youre younger than 59 1/2. If you decide to leave your 401 with your old employer, youll still be subject to taxes and penalties if you withdraw the money before retirement. However, leaving your money in a 401 can be a good way to keep it invested and grow over time.
Rolling over your 401 into an IRA is another option. With an IRA, youll have more control over how your money is invested. And, if you roll over your 401 into a Roth IRA, your withdrawals in retirement will be tax-free. Talk to a financial advisor to find out which option is best for you.
- You can keep your 401 with your former employer or transfer it to a new employers plan.
- You can also convert your 401 into an Individual Retirement Account via a 401 rollover.
- Another choice is to withdraw your 401, which may result in a penalty and taxes on the entire amount.
How Covid Retirement Plan Withdrawals Affect Your Taxes
Though you dont have to pay the 10% penalty on these withdrawals, youll still owe taxes on the money you withdraw. To make things a bit easier, though, the CARES Act allows you to spread the income over three different tax years.
For example, if you borrowed $30,000, you can apply $10,000 to your 2020 taxable income, $10,000 in 2021 and the last $10,000 in 2022. You must take at least one-third of the money in each year, though. You can also opt to take more in any year, including up to all of the money if you so choose.
If, in a later year, youve made back the money you withdrew, that is allowed. Youll have to file an amended return for any years with withdrawal money to get a refund. Again, the same rules apply for IRAs and 401s.
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