What Are Alternatives
Because withdrawing or borrowing from your 401 has drawbacks, it’s a good idea to look at other options and only use your retirement savings as a last resort.
A few possible alternatives to consider include:
- Using HSA savings, if it’s a qualified medical expense
- Tapping into emergency savings
- Transferring higher interest credit card balances to a new lower interest credit card
- Using other non-retirement savings, such as checking, savings, and brokerage accounts
- Using a home equity line of credit or a personal loan3
- Withdrawing from a Roth IRAcontributions can be withdrawn any time, tax- and penalty-free
How To Avoid Rmds
If you fail to take an RMD on time, you will have to pay a 50% tax on the amount you should have withdrawn. However, one easy and perfectly legal way to avoid RMDs is to rollover your IRA or 401 assets into a Roth IRA or Roth 401. Youll have a bigger tax bill the year you do it, but the IRS will not require you to take RMDs from these accounts. Theoretically, you can leave money in a Roth IRA or Roth 401 until your death, and it can continue growing tax-free. But as long as your assets have been in these accounts for at least five years, you can make tax-free and penalty-free distributions after reaching age 59.5. And at any time, you can withdrawal your own contributions penalty and tax free.
Early Ira Withdrawal Rules
Early withdrawals from traditional IRAs are also subject to income taxes and the 10% penalty. They have many of the same exceptions to the penalty as 401s, but there are a few differences.
You can withdraw early if you use the money to pay for certain higher education expenses, health insurance premiums that you have to pay while you’re not employed, or a first-time home purchase.
IRAs don’t require a QDRO to divide the account after a divorce, but they’re subject to certain rules all the same.
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Other Considerations For Required Minimum Distributions
Your 401k administrator might calculate your RMD, but its your ultimate responsibility to make sure the calculation is accurate. Note that you can withdraw more than your required minimum, but you cant apply the excess funds to your following years RMD.
If you own more than one 401k, you must calculate the RMD amount for each account. You can, however, withdraw your RMD amount from a single account. If you own different types of accounts, such as one IRA and one 401k, you must take RMDs from each one.
You might consider opting for a systematic withdrawal plan. SWPs provide income in the form of monthly, quarterly or annual withdrawals from 401k plans, which you can schedule to meet your RMD obligations.
How Long Does It Take To Cash Out A 401 After Leaving A Job
Depending on who administers your 401 account , it can take between three and 10 business days to receive a check after cashing out your 401. If you need money in a pinch, it may be time to make some quick cash or look into other financial crisis options before taking money out of a retirement account.
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How Do You Calculate A 401k Withdrawal At Age 70
Mandatory 401 withdrawals at age 70 1/2, known as required minimum distributions, are calculated by dividing the balance in the 401 account on December 31 of the previous year by the life expectancy of the account holder, reports Bankrate. Life expectancy is determined using the appropriate IRS uniform lifetime table.
401 account holders can withdraw more than the minimum distribution at any time after age 59 1/2, but required minimum distributions must begin at age 70 1/2, or account holders are subject to a 50 percent penalty tax on the amount that should have been distributed, according to the IRS. Account holders may withdraw larger amounts than the minimum, but the excess does not count towards the following years required minimum distribution. Although 401 administrators may help calculate the required minimum distribution, responsibility for calculating and withdrawing the correct amount lies with the 401 account holder.
There are three uniform lifetime tables, as reported by the IRS. The standard uniform lifetime table is used by a 401 owner whose wife is not more than 10 years younger. The Joint and Last Survivor table is used by an account holder whose only beneficiary is his wife who is more than 10 years younger. The Single Life Expectancy table is used by other beneficiaries of a 401 account.
How Taxes Affect How Much You Can Withdraw
Think in terms of a timeline, and figure out when it makes sense to turn certain sources of income on or off. One of the biggest factors youll want to consider in developing a retirement withdrawal plan is the amount of after-tax income that will be available to you over the course of your retirement years.
For example, traditional thinking says that you should delay withdrawals from your IRA accounts until you reach age 72, which is when you must begin taking required minimum distributions.
But this rule of thumb is often wrong. Many peoplealthough not allhave an opportunity to increase the amount of after-tax income available to them by taking IRA distributions early and delaying the start date of their Social Security benefits. Then, they can reduce what they’re withdrawing from retirement accounts when Social Security begins. Some years, they might withdraw much more from investment accounts than in other years, but the end result is typically more after-tax income.
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What Are The Rules For A 401 Distribution
You can withdraw money from your 401 penalty-free once you turn 59½. The withdrawals will be subject to ordinary income tax, based on your tax bracket. For those under 59½ seeking to make an early 401 withdrawal, a 10% penalty is normally assessed unless you are facing financial hardship, buying a first home, or needing to cover costs associated with a birth or adoption.
Rmd Rules When An Entity Inherits A Traditional Ira
If you have a traditional IRA, you can designate a beneficiary to be an entity instead of an individual. Examples include trusts, charities, and certain organizations. However, this doesnt mean they avoid RMD rules. In this case, the RMD depends on the age of the original account owner upon death.
So lets say the original account owner was still alive by April 1 following the year he or she reached age 72. In this instance, RMDs will be calculated based on the life expectancy factor of the original owner using the IRS Single Life Expectancy table.
Now, consider the account owner died before turning age 72. In this case, the entity must withdraw the entire balance in the account within five years following the year of death.
However, exclusive rules apply to Look-Through Trusts. You should consult a financial advisor and tax professional for specific guidelines on how the IRS treats RMDs in this case.
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But Why Would I Max Out My Roth Ira Before My 401k If Its So Good
Theres a lot of nerdy debate in the personal finance sphere about this very question, but our position is based on taxes and policy.
Assuming your career goes well, youll be in a higher tax bracket when you retire, meaning that youd have to pay more taxes with a 401k. Also, tax rates will likely increase in the future.
The Ladder of Personal Finance is pretty handy when considering what to prioritize when it comes to your investments, but it is just a tool. For more about the Ladder of Personal Finance and how to make it work for you, check out THIS video where I explain it.
PRO TIP: The video is less than three minutes long. It is worth your time.
Is It Possible For A Plan To Allow In
Indeed. The plan can specify that participants are limited to a maximum number of in-service distributions per year or that there is a minimum amount that can be taken . However, since imposing those sorts of restrictions requires that they be monitored, we dont see them in very many plans.
Another restriction we see a little more frequently is that in-service distributions can only be taken from accounts in which the participant is 100% vested.
If any of these restrictions are to be imposed, they must be written into the plan document and applied consistently across the board to all participants.
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Do You Pay Tax On 401 Contributions
A 401 is a tax-deferred account. That means you do not pay income taxes when you contribute money. Instead, your employer withholds your contribution from your paycheck before the money can be subjected to income tax. As you choose investments within your 401 and as those investments grow, you also do not need to pay income taxes on the growth. Instead, you defer paying those taxes until you withdraw the money.
Keep in mind that while you do not have to pay income taxes on money you contribute to a 401, you still pay FICA taxes, which go toward Social Security and Medicare. That means that the FICA taxes are still calculated based on the full paycheck amount, including your 401 contribution.
Early Withdrawals During A Recession
A recession spells out bad times for all. Gross domestic product falls and industrial production slows down. Most noticeably of all, unemployment rates rise. You may find yourself on the wrong side of that trend with dwindling savings. You do have a nice amount of money that you set aside for a future version of yourself.
It’s a tempting idea that many people follow through on. A study from the IRS conducted in 2013 found that in 2004, prior to the Great Recession, 13.3% of people with some retirement plan experienced a taxable retirement account distribution essentially they did an early withdrawal. That percentage rose to 15.4% in 2010.
An early withdrawal should be a last resort. If you can afford not to withdraw early, do so. However, like many other issues within personal finance, recessions impact income levels differently. The same survey states that lower-income households have a higher propensity for an early withdrawal because they’re more deeply impacted by the economic shock.
Note: Retirement savings in a 401 might decline as a result of a recession-induced bear market, which might also drive people to withdraw. The Great Recession set 401s back by over $2 trillion. Yet, despite the volatile markets over the last few years, the average 401 balance has stayed relatively steady, according to Fidelity.
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Tips On Retirement Income Planning
- A financial advisor can be a big help in putting together a retirement income plan that accounts for living expenses, taxes and other considerations. SmartAssets free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- To avoid a stiff penalty, make sure you withdraw your RMDs by the appropriate deadline. But dont worry. Most people satisfy their RMDs and then some within a given year. And to help you avoid some pitfalls, our retirement experts published a report on tips for understanding required minimum distribution rules.
Use A Portfolio Line Of Credit
You could also consider taking out a portfolio line of credit, which is essentially a loan backed by securities held in your portfolio, such as stocks or bonds. Interest rates on a portfolio line of credit tend to be lower than that of traditional loans or credit cards because theyre backed by collateral that the lender will receive in the event you cant pay back the loan.
However, if the value of your collateral falls, the lender can require you to put up additional securities. The lender could also become concerned with the securities being used as collateral. Government bonds will be viewed as much safer collateral than a high-flying tech stock.
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Should You Take A Distribution From Your 401 Or Ira
Like the CARES Act, the Consolidated Appropriations Act allows you to withdraw funds from both a 401 and an IRA, as long as the amount is up to $100,000 across all accounts. If you are deciding whether to take a distribution from either your IRA or a 401, think about factors such as each of the account’s typical rules around penalties and taxes. F
If You Withdraw Too Much
It will be important to track your withdrawals against your original plan at the time your withdrawal plan is designed, and you’ll also want to update your plan from year to year. Taking out too much money too soon can obviously cause you problems later.
We’ll use the example of Susan, whose investments did very well through her first few years of retirement. She insisted on taking out a lot of additional money during those years. She was warned that her plan had been tested against both good and bad investment markets and that she would be jeopardizing her future income by taking out additional profits early.
Rates of return in excess of 12% don’t go on forever, so she should have banked those excess returns to enable her to use them in years when the investments didn’t fare as well. Susan insisted on taking additional funds out immediately, and the markets went down a few years later. She didn’t have those additional profits set aside, and her accounts were severely depleted. She ended up living on a strict budget instead of having some extra “fun” money.
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Beginning At Age 72 You Must Withdraw Money From Your Retirement Accounts
If you have money in an individual retirement account, once you turn 72, the Internal Revenue Service requires that you withdraw money from this account every year, even if you still work.
In effect, once you turn 72, the IRS requires you to stop saving all your money in your individual retirement account IRA or most other employer-based retirement accounts, such as 401, 403 and 457 plans. You must withdraw it over time. Unfortunately, when you withdraw the money, the government gets to tax it. Remember that any money that you put into these accounts went in tax-free, before taxes. And, any money in an IRA can appreciate without any taxes on the appreciation until you withdraw the money.
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How To Calculate Your Rmd
So, how can you figure out how much you need to take out based on the above table? Heres how to do the calculation:
Make sure you do this for all of the traditional IRAs you have in your name. Once you add up all of the required minimum distributions for each of your accounts, you can take that total amount out of any of your IRAs. You dont have to take the minimum distribution from each account as long as the total money you withdraw adds up.
This only applies to traditional IRAs, not Roth IRAs. Note that the above RMD table also doesnt apply to you if you have a spouse who is the sole beneficiary of your IRA and who is more than 10 years younger than you.
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When To Consider A Retirement Early Withdrawal
You should consider making withdrawals from a retirement account only under dire circumstances. Given the financial and emotional impact that situations such as the COVID-19 pandemic as well as national disasters have had on Americans, there are situations when it could make sense to withdraw early.
What Is A 401 And How Does It Work
Before diving into whether you should use your 401 to buy a house, its important to first have a firm grasp on how, exactly, a 401 retirement account works.
Your 401 account is an earmarked savings account created specifically to help you prepare for retirement. As defined by the Internal Revenue Code of the IRS, 401 holders can claim a tax deduction and will see their contributions to the account accrue tax-free interest over time. The trade-off is that access to the account is strictly limited.
Withdrawals from a 401 should not be made before the account holder turns 59½, or before they turn 55 and have left or lost their job. Early withdrawals incur a 10% early withdrawal penalty on the amount of money being taken out of the account. This amount also immediately becomes subject to income tax, since its no longer in the protected retirement savings account.
While these regulations may seem harsh, they are in place to incentivize account holders to set aside enough money to support a comfortable retirement. That being said, its not illegal to withdraw money from your 401 early, and those funds can certainly be put toward a down payment on a house.
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