Tuesday, November 29, 2022

How To Get Money Out Of 401k Without Penalty

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Calculating The Withdrawal Amount

How to Cash Out 401K Early (without penalty)

There are three different methods you can choose for calculating the value of your withdrawals:

  • Fixed amortization, a fixed schedule of payment
  • Fixed annuitization, a sum based on annuity or life expectancy
  • Required minimum distribution , based on the account’s fair market value
  • A trusted financial advisor can help you determine which method is most appropriate for your needs. Regardless of which method you use, youre responsible for paying taxes on any income, whether interest or capital gains, in the year of the withdrawal.

    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.

    How To Withdraw From A 401 At Age 55

    Under the right circumstances, you can withdraw from a 401 at age 55 . If you retire, quit or get fired between age 55 and 59, you can withdraw without penalty from your 401. See IRS Publication 575

    The tax doesnt apply to distributions that are: From a qualified retirement plan after your separation from service in or after the year you reached age 55

    What is separation from service? Heres how the IRS defines it:

    To meet the requirements for the first exception in the list above, you must have separated from service in or after the year in which you reach age 55 . You cant separate from service before that year, wait until you are age 55 , and take a distribution.

    If you leave your job before age 55 you cant take a distribution without paying the 10% penalty. If you wait until after you turn 55 you can take a distribution without paying the 10% penalty.

    See page 34 of the publication.

    There are several important points to know about the Rule of 55.

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    Will My Credit Score Be Impacted If I Withdraw Early

    Withdrawing funds from your 401 early won’t impact your credit directly since the credit bureaus don’t track activity on your retirement accounts.

    Making an early withdrawal can indirectly affect your credit when you use the money to pay down outstanding debt. It may seem like an easy way to ease a debt burden or boost your credit, but in most cases, this shouldn’t be the only reason to withdraw funds from your 401. Such a move should only be considered in a financial emergency when you have exhausted all other options.

    Debt Relief Without Closing My 401k

    What Is the 401k Retirement Age?

    Before borrowing money from your retirement account, consider other options like nonprofit credit counseling or a home equity loan. You may be able to access a nonprofit debt management plan where your payments are consolidated, without having to take out a new loan. A credit counselor can review your income and expenses and see if you qualify for debt consolidation without taking out a new loan.

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    When Should You Make A 401 Early Withdrawal

    Considering the 10% penalty, financial planners often advise taking an early withdrawal from your 401 as a last resort. Since penalty-free withdrawals are available for a number of financial hardships and situations, plan participants who take an early withdrawal with a penalty are often in serious financial straits.

    Ive seen people take withdrawals for a number of reasons, Stiger says. Everything from a childs tuition to a spouses burial expenses the hope is that distributions are used for larger, more unexpected expenses like medical emergencies, keeping a home out of foreclosure or eviction, and in a down period, putting food on the table.

    Ultimately, taking an early withdrawal can make sense if you are able to take advantage of a penalty-free exception, use the Rule of 55 or the SEPP exemption, or take advantage of a topical change in rules, such as the Covid-related changes offered in 2020 as part of the CARES Act.

    It might make sense to exhaust other options firstcheck out these 10 ways to get cash nowbefore turning to your tax-deferred retirement account for an early withdrawal. And remember: Contributions to a Roth IRA can always be withdrawn without penalty if youre truly in a bind.

    No More Creditor Protection

    Once youve squared away how long it takes to cash out your 401, its time to think about consequences. The first is the loss of protection against creditors. If youre cashing out because creditors may come knocking, this is something you need to consider. Employer-sponsored 401 plans are often protected against creditors, bankruptcy proceedings, and civil lawsuits. Once youve cashed the funds out, theyll be subject to action along with your other assets.

    But before you assume this could be a problem, check to make sure your plan isnt vulnerable for other reasons. If youre in the process of divorcing or are already divorced, the other party could be able to snag a portion of the funds under a qualified domestic relations order. Funds in a 401 can also be seized to pay tax debts and federal penalties.

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    Acceptable Reasons For Hardship Withdrawals

    The IRS considers the following as acceptable reasons for a hardship withdrawal:

    • Medical expenses for you, a spouse or a family member.
    • Costs you might incur related to the purchase of your principal residence . This could include a down payment, but not the ongoing mortgage payments.
    • To prevent your eviction from or the foreclosure of your principal residence.
    • Funeral expenses for you, your spouse, other dependents, or family members.
    • To cover post-secondary educational expenses for the next 12-months for you, your spouse and other family members. This includes things like tuition, fees, room and board, among others.
    • Expenses related to the repair of your principal residence that fall under the IRS guidelines of what constitutes a casualty loss.

    Additionally, IRS rules prohibit you from contributing to the plan for a period of at least six months.

    What Are The Penalties For Withdrawing From My 401 Before Age 59

    Can I Cash Out My 401(K) Without Quitting My Job?

    Unless you fall into one of the special exemption categories, you will pay a penalty of 10% of the amount of funds you withdraw. This can get quite pricey and really cut into your retirement savings. If you must make a withdrawal before reaching retirement age, then make sure you check the list of exemptions to the penalty. If you can qualify under one of the exemptions, then you will not be forced to pay this extra penalty.

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    Requesting A Loan From Your 401

    If you do not meet the criteria for a hardship distribution, you may still be able to borrow from your 401 before retirement, if your employer allows it. The specific terms of these loans vary among plans. However, the IRS provides some basic guidelines for loans that won’t trigger the additional 10% tax on early distributions.

    Whether you can take a hardship withdrawal or a loan from your 401 is not actually up to the IRS, but to your employerthe plan sponsorand the plan administrator the plan provisions they’ve established must allow these actions and set terms for them.

    For example, a loan from your traditional or Roth 401 cannot exceed the lesser of 50% of your vested account balance or $50,000. Although you may take multiple loans at different times, the $50,000 limit applies to the combined total of all outstanding loan balances.

    See If You Qualify For An Exception To The 10% Tax Penalty

    Generally, the IRS will waive it if any of these situations apply to you:

    • You choose to receive substantially equal periodic payments. Basically, you agree to take a series of equal payments from your account. They begin after you stop working, continue for life and generally have to stay the same for at least five years or until you hit 59½ . A lot of rules apply to this option, so be sure to check with a qualified financial advisor first.

    • You leave your job. This works only if it happens in the year you turn 55 or later .

    • You have to divvy up a 401 in a divorce. If the courts qualified domestic relations order in your divorce requires cashing out a 401 to split with your ex, the withdrawal to do that might be penalty-free.

    Other exceptions might get you out of the 10% penalty if you’re cashing out a 401 or making a 401 early withdrawal:

    • You become or are disabled.

    • You rolled the account over to another retirement plan .

    • Payments were made to your beneficiary or estate after you died.

    • You gave birth to a child or adopted a child during the year .

    • The money paid an IRS levy.

    • You were a victim of a disaster for which the IRS granted relief.

    • You overcontributed or were auto-enrolled in a 401 and want out .

    • You were a military reservist called to active duty.

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    Borrowing Money From My 401k

    It may seem like an easy way to get out of debt to borrow from your retirement accounts for DIY debt consolidation, but you can only borrow $50,000 or half the vested balance in your account, if its less than $50,000. You wont face a tax penalty for doing so, like you would with an out-right withdrawal, but youll still have to pay the money back.

    And unlike a home equity loan where payments can be drawn out over a 10-to-30-year period, most 401k loans need to be paid back on a shorter time table like five years. This can take a huge chunk out of your paycheck, causing you even further financial distress. Borrowing money from your 401k also limits the ability of your invested dollars to grow.

    Paying off some of your debt with a 401k loan could help improve your debt-to-income ratio, a calculation lenders make to determine how much debt you can handle. If youre almost able to qualify for a consolidation or home equity loan, but your DTI ratio is too high, a small loan from your retirement account, amortized over 5 years at a low interest rate may make the difference.

    Check If You Qualify For Penalty Exemption

    401(k) Withdrawal Rules

    The IRS will typically waive the penalty on the withdrawal in the following scenarios:

    • You lost your job. Youll only get the exemption if you lost your job around your 55th birthday or later. The age limit is 50 for people in certain government jobs like border protection, firefighting, federal law enforcement, etc.
    • You have to split the 401 after a divorce. If the court order in your divorce cases requires you to cash out your 401 after a divorce, you likely wont pay penalties on the withdrawal.
    • You agree to receive equal periodic payments. Under this arrangement, youll agree to take some equal payments after you stop working. The payments will continue for life like some sort of annuity. This option is a bit more complex, with numerous rules. Talk to a professional to weigh your options here.

    Below are other scenarios that may qualify you for early withdrawal without penalties:

    • You need the money to pay an IRS levy.
    • You recently adopted a child or gave birth to yours.
    • Youre disabled or just became disabled.
    • You were affected by a disaster for which the IRS has provided relief.
    • You want out of an auto-enrolled 401 .
    • Youre a military reservist thats just been called to active duty.

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    Consider The Costs Of Taking Retirement Money

    Giving Americans the ability to take $100,000 in penalty-free withdrawals is probably rooted in the right place, says Timothy Ellis Jr., a certified financial planner with Memphis-based Waddell & Associates.

    But those withdrawals could have a long-term negative impact on retirement plans and needs moving forward, Ellis says.

    Especially because the worst time to withdraw investment assets is in the middle of a dramatic market downturn. Because the investments are worth less, consumers may have to withdraw a larger percentage of the account, Ellis says.

    Then there’s the opportunity cost to raiding your retirement savings early. “Accessing retirement plan accounts, especially for younger workers, can put a permanent dent in plan balances,” Ellis says. In fact, for an investor who makes steady retirement contributions over their career, the amounts saved during the first 10 years may end up accounting for half of their retirement account balance at age 65.

    That’s because compounding is one of the most powerful tools to boost retirement savings, and making a withdrawal, especially during the early stages of investing, reduces that ability, Ellis adds. Even a smaller withdrawal adds up in the long run. A $5,000 balance today could be worth $57,900 in 35 years, assuming a 7% annual rate of return.

    The Age 55 Exemption Applies Only To The Date Employment Endednot When You Begin Taking Distributions

    This is important for those entering retirement early. For example, if you retired from Company ABC at age 50, you would still be subject to the penalty tax if you take distributions at age 55. Since your employment ended before the year in which you turned 55, youd have to wait until age 59 ½ for penalty-free withdrawals.

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    Series Of Substantially Equal Payments

    If none of the above exceptions fit your individual circumstances, you can begin taking distributions from your IRA or 401k without penalty at any age before 59 ½ by taking a 72t early distribution. It is named for the tax code which describes it and allows you to take a series of specified payments every year. The amount of these payments is based on a calculation involving your current age and the size of your retirement account. Visit the IRS website for more details.

    The catch is that once you start, you have to continue taking the periodic payments for five years, or until you reach age 59 ½, whichever is longer. Also, you will not be allowed to take more or less than the calculated distribution, even if you no longer need the money. So be careful with this one!

    How Does A Cares Act 401k Withdrawal Work

    Personal Finance: 401(k) : How to Withdraw 401(k) Money With No Penalty

    Plan participants should speak to their plan administrator to ask about the process for requesting a 401k or IRA withdrawal. The participant may need to complete a withdrawal form and provide documentation to substantiate the nature of their hardship.

    The request will need to be approved by either a committee or a designated person responsible for making hardship-withdrawal decisions. If the participant qualifies for a hardship withdrawal based on IRS regulations, the plan administrator will process the request. Depending on the plan administrator, approving and processing the hardship request can take several weeks. For that reason, a hardship withdrawal may not be a great option for the most time-sensitive financial needs.

    If the participant doesnt qualify for the distribution, the administrator will deny the request and notify the participant.

    Prior to the CARES Act, plans would automatically withhold 20% of early withdrawals for tax purposes. The CARES Act eliminated the 20% automatic withholding on 401k withdrawals. However, participants may want to avoid spending the full amount withdrawn in order to have funds available to cover the tax bill later.

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    Our Take: When Can You Withdraw From Your 401k Or Ira Penalty

    There are a number of ways you can withdraw from your 401k or IRA penalty-free. Still, we recommend not touching your retirement savings until you are actually retired. Compounding is a huge help when it comes to maximizing your retirement savings and extending the life of your portfolio. You lose out on that when you take early distributions. To see how much compounding can affect your 401k account balance, check out our article on the average 401k balance by age.

    We understand that its always possible for unforeseen circumstances to arise before you reach retirement. Being aware of the exceptions allows you to make informed decisions and possibly avoid paying extra fees and taxes.

    To take control of your finances, a good place to start is by stepping back, getting organized, and looking at your money holistically. Personal Capitals free financial dashboard will allow you to:

    The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

    Who Should Withdraw From Their 401 Early

    Just because you qualify for a hardship-related withdrawal doesnt mean you should take one without weighing all your other options.

    The experts we spoke with were all in agreement that withdrawing from your 401 shouldnt be your first move. However, they also indicated that if youre truly in need, then you should take advantage of the CARES Acts allowances.

    It should be a last resort option. People shouldnt get carried away and start using their 401 assets just because they can, Pfau says.

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    How Early Retirement Plan Withdrawals Work Under Normal Circumstances

    When there isnt a global pandemic impacting the livelihoods of the entire nation, withdrawing money early from a retirement plan is a serious decision. Thats because it carries with it some pretty serious consequences: namely, a 10% penalty paid on all of the money you withdraw, in addition to paying normal taxes. This, of course, assumes it is not a Roth plan, where the money has already been taxed.

    Even if youre willing to pay the penalty, you have get approval from your plan beforehand. This is typically known as a hardship withdrawal. Some plan sponsors may not be willing to grant them, so make sure you check with your HR department before you plan on making one. Acceptable reasons for a hardship withdrawal include:

    • Paying certain medical bills for you or family members
    • Avoiding foreclosure on or to buy a primary residence
    • Covering educational expenses for you or family members
    • Paying for family funeral expenses
    • Paying for some home repairs, such as those necessary after a natural disaster

    Note that these reasons still carry the 10% penalties, in addition to taxes. There are a few instances where the penalty is waived:

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