Understanding Early Withdrawal From A 401
Withdrawing money early from your 401 can carry serious financial penalties, so the decision should not be made lightly. It really should be a last resort.
Not every employer allows early 401 withdrawals, so the first thing you need to do is check with your human resources department to see if the option is available to you.
As of 2021, if you are under the age of 59½, a withdrawal from a 401 is subject to a 10% early withdrawal penalty. You will also be required to pay regular income taxes on the withdrawn funds.
For a $10,000 withdrawal, when all taxes and penalties are paid, you will only receive approximately $6,300.
Use A Professionally Managed Fund Or Get Advice
Investing too conservatively could also jeopardize your lifestyle or cause you to run out of money. Striking the right balance sometimes requires professional management. Your 401 plan may offer professionally managed fund options, such as target-date funds, for retirees. And your 401 provider might offer personalized investment advice. Ask your provider about your options for getting help. And if you think face-to-face advice might be better for your needs, find a financial professional with experience helping retirees.
Leave Your Assets Where They Are
If the plan allows, you can leave the assets in your former employers 401 plan, where they can continue to benefit from any tax-advantaged growth. Find out if you must maintain a minimum balance, and understand the plans fees, investment options, and other provisions, especially if you may need to access these funds at a later time.
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People May Have Different Reasons For Withdrawing Funds Early From A 401k
- Financial Hardship: People sometimes withdraw funds early due to financial hardship . Example include: medical care, expenses related to the purchase of a home, tuition, and funeral expenses
- Discretionary Spending: People may withdraw funds from a 401K because they prefer to have the money now rather than save it for retirement. In general, we do not recommend this strategy
- Early Retirement: Some people retire earlier than the standard retirement age. In this case, it is understandable why they may want to access funds early since they are no longer working
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What If You Are The Beneficiary Of A 401 Plan
If you are the beneficiary of a 401 plan, you’ll have a little bit different set of rules that apply to taking money out of the 401 plan. Your choices will depend on whether you were the spouse or non-spouse of the 401 plan participant and whether the 401 plan participant had reached age 70 1/2the age for required minimum distributions .
If you or your spouse turned 70 1/2 before Jan. 1, 2020, the age for RMDs is still 70 1/2. If you or your spouse turned 70 1/2 on or after Jan. 1, 2020, the age for RMDs is 72.
Keeping Your 401 With Your Former Employer
If your former employer allows you to keep your funds in its retirement account after you leave, this may be a good option, but only in certain situations, says Colin F. Smith, president of The Retirement Company in Wilmington, N.C.
Staying in the old plan may make sense if you like where you are and they may have investment options you cant get in a new plan, says Smith. The other main advantage is that creditors cannot get to it.
Additional advantages to keeping your 401 with your former employer include:
- Maintaining the money management services.
- Special tax advantages: If you leave your job in or after the year you reach age 55 and think youll start withdrawing funds before turning 59½, the withdrawals will be penalty free.
Some things to consider when leaving a 401 at a previous employer:
- If you plan on changing jobs a few more times before retirement, keeping track of all of the accounts may become cumbersome.
- You will no longer be able to contribute to the old plan and in some cases, may no longer be able to take a loan from the plan.
- Your investment options are more limited than in an IRA.
- You may not be able to make a partial withdrawal and may have to take the entire amount.
- If your assets are less than $5,000 you may have to proactively remain in the plan. If you dont notify your plan administrator or former employer of your intent, they may automatically distribute the funds to you or to a rollover IRA.
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Not All Retirement Accounts Are Alike
First off, you need to know the difference between a 410 and an individual retirement account . Simply put, a 401 is offered through your place of work and involves your contributions . An IRA is a private investment funded solely by your own money. It can be a bit more difficult, and in some cases costly to take money from a 401 plan, if you are still working, Blayney notes.
But what if you have to take money out, or feel compelled to do so? Blayney lists a number of circumstances when tapping or leveraging retirement funds might be a possibility.
Cares Act 401 Early Withdrawals
The CARES Act contains a provision allowing those who are under age 59 ½ to take a distribution from their retirement plan while working, waiving the 10% penalty that would normally be associated with this type of distribution.
The distributions are still subject to income taxes, but these taxes can be spread over a three-year period. You can re-contribute some or all of the money taken via this route over a three-year period and avoid some or all of these taxes.
These distributions require that you document that COVID-19 has impacted you or a family member. This means that you or a family member has contracted the virus or that you or a family member has been financially impacted by COVID-19 in ways that might include a job loss or reduced income. For a 401 plan, the ability to take these distributions is not automatic, your employer needs to adopt this as a provision of the plan.
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Withdrawing From A 401 After Leaving The Company Without A Penalty
In any of the following situations, you may qualify for early withdrawal without being subjected to any penalty:
If you leave a company the same year you turn 55 years old
If you suffer from total or permanent disability
If you cash out in equal installments spread over an expected period of your remaining lifetime
If you need to pay for medical expenses, which are more than 10% of your income
If as a military reservist, you have been called to active duty
Take An Early Withdrawal
Perhaps youre met with an unplanned expense or an investment opportunity outside of your retirement plan. Whatever the reason for needing the money, withdrawing from your 401 before age 59½ is an option, but consider it a last resort. Thats because early withdrawals incur a 10% penalty on top of normal income taxes.
While an early withdrawal will cost you an extra 10%, it will also diminish your 401s future returns. Consider the consequences of a 30-year-old withdrawing just $5,000 from his 401. Had the money been left in the account, it alone would have been worth over $33,000 by the time he turns 60. By withdrawing it early, the investor would forfeit the compound interest the money would accumulate in the years that follow.
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Early Withdrawal Penalties Dont Always Apply
The 10% penalty doesnt apply on an early distribution if:
- The participant has died and their beneficiary is collecting the balance
- The participant has a significant disability
- The person is separated from service during or after the year that the participant turned 55 according to IRS Publication 575
- Is being made to a payee under a qualified domestic relations order sometimes called a QDRO
- The participant needs it for medical care
- The participant accidentally made an excess contribution or the employer accidentally made an excess contribution, and the contribution is withdrawn in the year it was made
- The participant needs it because of a natural disaster that the IRS has specifically indicated as qualified for an early penalty-free withdrawal
What Is The Tax Penalty For Withdrawing Money From A 401
It depends on when you make the withdrawal. If you are age 59 1/2 or older, then there is no tax penalty. However, if you make a withdrawal before reaching this age, you will be charged an extra 10% penalty on top of your regular income taxes that you pay on the funds. In some cases, you might be able to take a withdrawal without being required to pay the penalty. Some situations include hardship withdrawals, unreimbursed medical expenses, education related expenses, qualified reservists, and death. This is not an exhaustive list, and you should contact your financial planner to discuss your specific situation to see if you can qualify for a penalty-free withdrawal.
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Cashing Out A : What A 401 Early Withdrawal Really Costs
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Contributing to a 401 can be a Hotel California kind of experience: Its easy to get your money in, but its hard to get your money out. That is, unless youre at least 59½ years old thats when the door swings wide open for a 401 withdrawal. But try cashing out a 401 with an early withdrawal before that magical age and you could pay a steep price if you dont proceed with caution.
Tips On 401 Withdrawals
- Talk with a financial advisor about your needs and how you can best meet them. SmartAssets financial advisor matching tool makes it easy to quickly connect with professional advisors in your local area. If youre ready, get started now.
- If youre considering withdrawing money from your 401 early, think about a personal loan instead. SmartAsset has a personal loan calculator to help you figure out payment methods.
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Retirement Funds Don’t Have To Be Off
Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
For those who invest in their 401 plan, the traditional thinking is to wait until retirement before taking distributions or withdrawals from the account. If you take funds out too early, or before the age of 59½, the Internal Revenue Service could charge you with a 10% early withdrawal penalty plus income taxes.
However, life events can happen, which might put you in a position where you need to tap into your retirement funds earlier than expected. The good news is that there are a few ways to withdraw from your 401 early without incurring a penalty from the IRS.
Impact Of A 401 Loan Vs Hardship Withdrawal
A 401participant with a $38,000 account balance who borrows $15,000 will have $23,000 left in their account. If that same participant takes a hardship withdrawal for $15,000 instead, they would have to take out $23,810 to cover taxes and penalties, leaving only $14,190 in their account, according to a scenario developed by 401 plan sponsor Fidelity. Also, due to the time value of money and the loss of compounding opportunities, taking out $23,810 now could result in tens of thousands less at retirement, maybe even hundreds of thousands, depending on how long you could let the money compound.
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Prepare Your 401 For Its New Job Before You Retire
You need to plan for retirement withdrawals so you can prepare your 401 for its new jobsupporting you. That means figuring out how much youll be spending, understanding how to take money out of your account, and looking at how your investments may finance your retirement lifestyle for as long as you need them.
For complete information about a particular investment option, please read the fund prospectus. You should carefully consider the objectives, risks, charges and expenses before investing. The prospectus contains this and other important information about the investment option and investment company. Please read the prospectus carefully before you invest or send money. Prospectus may only be available in English.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice . Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
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How To Cash Out Your 401
Since 1982, American workers have been saving for retirement by contributing to 401 plans. A type of defined contribution plan offered by many employers, a traditional 401 allows an employee to elect for his employer to contribute up to 15 percent of his monthly pay to the plan. Some employers will match the amount set aside up to a certain amount. The employee then chooses from a number of funds — including various money market, mutual and bond funds — in which the money is invested.
The employee will ultimately receive the balance in the account, which fluctuates based on changes in the value of the investments, as well as the amount of contributions to the account. The employee is not taxed on the money in the plan until it’s withdrawn. Additionally, 401 money is protected in the event the company sponsoring the plan goes bankrupt, although some plans require the employee to be enrolled for a certain amount of time before the portion of employer contributions to the balance are protected .
About 60 percent of households nearing retirement age have 401-type accounts, and as the national economy continues to sputter, many are turning to this portion of their nest egg for help. While the money in a 401 account ultimately belongs to account holder, cashing out a 401 early can have dire affect on a person’s financial security .
Here are some things you should know before cashing out your 401.
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Avoid The 401 Early Withdrawal Penalty
While the age for avoiding the penalty is normally 59 1/2, there is an exception to the age rule. If you leave a job or are terminated at age 55 or later, then you can make withdrawals from your account with that employer without paying the penalty. Make sure that you do not make withdrawals from any other plans you might have as those will still be subject to the penalty.
Likewise, remember that there are even heavier penalties for missing required minimum distributions . Upon reaching age 72, you are required to withdraw certain amounts from your account. If you fail to make the withdrawal, then you will receive a penalty of 50% of the amount of the required distribution. Suppose you were required to withdraw $8,000 from your 401. If you miss that distribution, then you will owe $4,000 in the penalty alone!
Withdrawals After Age 59 1/2
Age 59 1/2 is the magic number when it comes to avoiding the penalties associated with early 401 withdrawals. You can take penalty-free withdrawals from 401 assets that have been rolled over into a traditional IRA when you’ve reached this age. You can also take a penalty-free withdrawal if your funds are still in the 401 plan, and you’ve retired.
You can take a withdrawal penalty-free if you’re still working after you reach age 59 1/2, but the rules change a bit. Check with the plan administrator about its specific rules if you’re still working at the company with which you have your 401 assets.
Your plan might offer an “in-service” withdrawal that allows you to access your 401 assets penalty-free, but not all plans offer this option. And remember, the withdrawal will still be subject to income taxes, even if it’s not penalized.
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