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 The amount withdrawn from a 401 is also limited to what is necessary to satisfy the need.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.
K Early Withdrawal Hardship Or Loan: Whats The Difference
Knowing the differences between a 401k early withdrawal, a hardship withdrawal, and a 401k loan is crucial. Due to the many obstacles to make a 401k early withdrawal, you may find you want to keep it untouched. If youre convinced you still need to use your 401k for financial assistance, consult with a trusted financial advisor to figure out the best option.
When Does This Apply?
|Your funds are withdrawn to pay off large debts or finance large projects.||Your 401k fund is typically subject to taxes and penalties.|
|Youre only eligible for this type of withdrawal under circumstances such as a pandemic or natural disasters.||Withdrawals cant exceed the amount of the need and the funds are still subject to taxes and penalties.|
|The loan must be paid back to the borrowers retirement account under the plan.||The money isnt taxed if the loan meets the rules and the repayment schedule is followed.|
Disadvantages Of Closing Your 401k
Whether you should cash out your 401k before turning 59 ½ is another story. The biggest disadvantage is the penalty the IRS applies on early withdrawals.
First, you must pay an immediate 10% penalty on the amount withdrawn. Later, you must include the amount withdrawn as income when you file taxes. Even further down the road, there is severe damage on the long-term earning potential of your 401k account.
So, lets say at age 40, you have $50,000 in your 401k and decide you want to cash out $25,000 of it. For starters, the 10% early withdrawal penalty of $2,500 means you only get $22,500.
Later, the $25,000 is added to your taxable income for that year. If you were single and making $75,000, you would be in the 22% tax bracket. Add $25,000 to that and now youre being taxed on $100,000 income, which means youre in the 24% tax bracket. That means youre paying an extra $6,000 in taxes.
So, youre net for early withdrawal is just $16,500. In other words, it cost you $8,500 to withdraw $25,000.
Beyond that, you reduced the earning potential of your 401k account by $25,000. Measured over 25 years, the cost to your bottom line would be around $100,000. That is an even bigger disadvantage.
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Exceptions To The Penalty
The IRS permits withdrawals without a penalty for certain specific uses. These include a down payment on a first home, qualified educational expenses, and medical bills, among other costs.
As with the hardship withdrawal, you will still owe the income taxes on that money, but you won’t owe a penalty.
How To Cash Out A 401k
The money in a 401 is your money, but you can’t touch it until you are 59½ and no longer work for the same employer. What if you need the funds? Can you cash them out?
The IRS and many 401 administrators have strict rules regarding 401 withdrawals. Even though it’s your money, you put it aside for retirement and the IRS will do what they can to make sure it stays there, at least until you are of age.
Keep reading to learn how you can cash out a 401 and if it makes sense to do so.
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How Do You Take A Withdrawal Or Loan From Your Fidelity 401
If you’ve explored all the alternatives and decided that taking money from your retirement savings is the best option, you’ll need to submit a request for a 401 loan or withdrawal. If your retirement plan is with Fidelity, log in to NetBenefits®Log In Required to review your balances, available loan amounts, and withdrawal options. We can help guide you through the process online.
Early Withdrawal // 11 Ways To Cash Out Without Penalty
If you are in financial need, it might seem extremely tempting to simply withdraw some money from your 401, IRA, or other retirement account to cover the need. However, that withdrawal generally comes with a heavy penalty of 10% of the withdrawal amount. Retirement accounts are intended to be used for retirement, so the IRS imposes this penalty to discourage you from withdrawing money from your retirement savings. But what if you are in a true financial hardship? When can you withdraw from your 401 without this penalty? In some cases, you might be able to take some cash from your 401 without a penalty. Here is everything you need to know about early withdrawals from your 401 plus some ways that you can cash out without a penalty.
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Ira Rollover Bridge Loan
There is one final way to borrow from your 401k or IRA on a short-term basis. You can roll it over into a different IRA. You are allowed to do this once in a 12-month period. When you roll an account over, the money is not due into the new retirement account for 60 days. During that period, you can do whatever you want with the cash. However, if its not safely deposited in an IRA when time is up, the IRS will consider it an early distribution. You will be subject to penalties in the full amount. This is a risky move and is not generally recommended. However, if you want an interest-free bridge loan and are sure you can pay it back, its an option.
Options For Cashing Out A 401 After Leaving A Job
The amount in your 401 account, including your contribution, your employers contribution, and any earnings on your investments, belongs to you and can supplement your retirement fund. The huge amount of money accumulated in your 401 account may tempt you to cash out your plan, but its in your best interest not to do so.
Leaving your account with your old employer may not a good idea. There are chances that you may forget the account after some time. You can, instead rollover to your new employer or even set up an IRA to roll 401 funds into.
Rolling over your 401 to an IRA gives you the flexibility to invest your funds the way you want. However, in some states like California, your creditors have easier access to your IRA funds than the money kept in a 401 account. If you see any potential claim or lawsuit against you, you may want to let your funds lie in a 401 account rather than transferring into an IRA.
Alternatively, if you are eligible for the 401 plan of your new employer, you may want to roll over your old 401 to your new account. No matter where you invest, always consider minimizing the risk by diversifying your portfolio. You may never want to invest a large portion of your savings in a single company, no matter how much you trust it.
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How Much Are You Penalized For A 401k Early Withdrawal
On the surface, withdrawing funds from your 401k might not seem like a bad option under extenuating circumstances, but you could face penalties. Young adults are especially prone to early withdrawals because they figure they have plenty of time to replace lost funds.
If youre not experiencing a significant hardship, 401k early withdrawal probably isnt the right choice for you. Ultimately, you could lose a substantial portion of your retirement savings if you choose to withdraw your 401k early to use the money to make other risky financial moves. Below, lets delve further into the penalties that usually apply when you withdraw early.
Medical Expenses Or Insurance
If you incur unreimbursed medical expenses that are greater than 10% of your adjusted gross income in that year, you are able to pay for them out of an IRA without incurring a penalty.
For a 401k withdrawal, if your unreimbursed medical expenses exceed 7.5% of your adjusted gross income for the year then the penalty will likely be waived.
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Do You Get Your 401 If You Quit
Be aware of the following rules regarding your old 401 account:
If your 401 has a total investment of more than $5,000, your employer may allow you to leave the account with them even after you quit the job.
If your account has a balance of less than $1,000, your employer may force you out and pay the amount left in your account with a check.
If the total investment amount in your old 401 is between $1,000 and $5,000 and your employer wants to force you out, they must transfer the amount to your IRA.
Youll Owe Taxes And Possible Penalties
If you cash in your 401 plan, and you have not yet reached age 59 1/2, then the dollar amount you withdraw will be subject to ordinary income taxes and a 10% penalty tax.
If you are not yet age 59 1/2, your plan will likely enforce a required 20% amount withheld from any balance that you cash out to cover federal taxes. So, for every $1,000 you cash in, you would receive about $800. The other $200 would be sent to the IRS by your 401 administrator. At the end of the year, the 401 plan will send you a tax form called a 1099R that shows the amount of taxes withheld on your behalf.
In general, you should not cash out your 401. Instead, roll it over into an IRA. When you calculate how much money you would lose by cashing out the account, the choice will become clear. Use an early-withdrawal calculator to help you see how much a withdrawal will cost you.
When you file your income tax return, you must include any cashed-out amounts from your 401 plan as regular income, along with your other sources of income. The amount flows into your tax return on the first page, and, based on your total income and deductions, you will either owe additional tax or receive a refund.
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Seek Out Professional Help
If youre managing your account on your own and choosing investments from the menu your employer offers, now is a great time to take advantage of advice if its available to you, Williams said. These advice services are usually free or low cost.
Moreover, many financial advisers take middle-income clients and have reasonable fees. Interview a few. There are searchable databases at sites of the National Association of Personal Financial Advisors, the Financial Planning Association, XY Planning Network and the Certified Financial Planner Board of Standards.
Find one you like and then ask the questions to help you understand and give you the sense of control of your retirement savings if that recession does come to pass.
Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter
Penalties For Cashing Out Your 401 Early
For employees who are not yet eligible to withdraw money from their 401 , if you want your money early, you’re going to pay for it. All early withdrawals from a 401 plan are subject to a 10 percent excise tax. However, as in all aspects in life, there are exceptions to this rule. Distributions not subject to the excise tax include:
- distributions to an employee who is 55 or older and no longer works for the employer sponsoring the plan
- distributions to pay a domestic relations order such as child support or alimony
- distributions to pay off tax debt
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Decide How Much To Withdraw
All early withdrawals from your 401 are taxed as ordinary income. Thats the case even if the withdrawal was covered by an exception. The IRS typically withholds 20% of an early withdrawal to cover taxes, and that is in addition to the 10% penalty for a non-hardship withdrawal. Youll need to account for these amounts when you calculate how much to withdraw. For example, if you withdrew $10,000 from your 401, you might only receive $7,000 after the 20% IRS tax withholding and a 10% penalty.
How Much Tax Do I Pay On An Early 401 Withdrawal
The money will be taxed as regular income. That’s between 10% and 37% depending on your total taxable income.
In most cases, that money will be due for the tax year in which you take the distribution.
The exception is for withdrawals taken for expenses related to the coronavirus pandemic. In response to the coronavirus pandemic, account owners have been given three years to pay the taxes they owe on distributions taken for economic hardships related to COVID-19.
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Alternatives To Cashing Out A 401k
It is highly recommended that you never take a 401k cash out. The money is there to secure your financial independence in retirement. Thats only possible if its allowed to grow to meet your income needs. Cashing out just $10,000 at the age of 40 years old will cost you over $60,000 by the time you reach 60 years old assuming a 33% tax bracket and 7% annual return. Taxes and withdrawal penalties would cost you an immediate $4,300 of that amount.
If you need money, there are alternatives to cashing out a 401k. These options are available while you are still working with the employer that manages the 401k.
- Consider a home equity line of credit or other low-interest loan before cashing out a 401k plan. Personal loans and other types can carry high interest rates but may still cost less than the taxes and penalties youll pay on a 401k cash out
- Go into emergency spending mode. Cut out all non-essential spending for a few months before considering cashing out a 401k. Talk with your creditors to get extensions where you can and avoid digging yourself deeper in debt
- Borrow or withdraw from Roth IRAs first. You may still be jeopardizing your retirement goals but youve already paid taxes on money contributed to a Roth account so it may ultimately be cheaper than a 401k cash out
Whats The Difference Between A Withdrawal And A 401 Loan
With a 401 loan, you must repay the money back into your account over a period of time. With a standard withdrawal, there are no repayment requirements. You will be charged interest on the loan, although you are technically paying the interest back to yourself. The money goes back into your 401 account, and you usually can spread the payments out up to 5 years. If you are using the money for a down payment on a home, you can even spread them over 15 years. A loan is usually a much better option than a withdrawal because at least you will be replacing the money. However, not all plans offer 401 loans, so that might not be an option for you.
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Keep Cool And Review Your Asset Allocation For Diversification
Now is the perfect time to consider your risk tolerance.
Asset allocation, diversification and periodic rebalancing are just about the most certain protection strategies for your investments, Rob Williams, managing director of financial planning, retirement income and wealth management at Charles Schwab, told Yahoo Money. Of course, developing a long-term strategic asset allocation plan is key to your ability to retire. But sticking to that plan regardless of market swings or recession periods is even more important.
Your age is a factor here.
If you have 10 years or more before you’re ready to start taking distributions, youre probably in a position to ride out the recession and allow time for your stocks to rebound, Lazetta Braxton, a Certified Financial Planner and co-founder of 2050 Wealth Partners, a fee-only financial planning and wealth management firm, told Yahoo Money.
One simple equation many financial planners recommend is the percentage of retirement money you have invested in equities should be 110 minus your age.
Investing in the stock market does come with a dollop of risk. That said, over time youre generally paid back with higher returns than if you had parked the retirement savings in plain vanilla certificates of deposit, money market accounts, and bonds.