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Alternatives To Cashing Out A 401
If you’re in a dire financial situation where you need money right away, consider alternatives to cashing out your 401 early. Even if you’re covered under an exemption, removing money from your retirement funds will diminish your retirement savings and hurt you in the future.
Here are alternatives you might want to consider before cashing out early:
Roth Ira Hardship Withdrawals
If turning to your retirement savings is your last resort and you have a Roth IRA, this is the account you may want to consider tapping into first. The contributions you make into these accounts are taxed before they go in. So the IRS cant tax your contributions twice.
You can withdraw your contributions from a Roth IRA at any time without penalty. So if your Roth IRA contributions have been large enough to cover your financial burden, it might make sense to withdraw these first. Again, not the best financial decision. But as a last resort, youd at least avoid taxes and penalties.
However, its important to keep in mind were talking about contributions here.
This is the money you put into these accounts via automatic paycheck deduction or a bank transfer you initiated. This is separate from the earnings your contributions make from investment funds, interest, dividends or any other source.
The IRS doesnt permit you to withdraw any investment earnings on your contributions tax-free unless you meet two requirements. First, you have to be at least 59.5-years-old. Second, your account must have been open for at least five years. You must meet both stipulations before you can make tax-free qualified withdrawals from a Roth IRA.
Its also important to note that while you can withdraw your own contributions from a Roth IRA at any time, this is not the case with a Roth 401.
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There Are Some Situations In Which It Can Be Advisable To Take An Early 401k Withdrawal
- It may be beneficial to cash out a portion of your 401K if you have a loan that has very high interest. For example, taking an early distribution on your 401K be wise to pay down credit card or personal loan with a very high interest rate. In this case, you may be financially better off cashing out the 401K and paying the penalty than continuing to pay that interest. However, it is important to do the math to determine whether its better to cash out a portion of the 401K or not
Most People Have Two Options:
Whether youre considering a loan or a withdrawal, a financial advisor can help you make an informed decision that considers the long-term impacts on your financial goals and retirement.
Here are some common questions and concerns about borrowing or withdrawing money from your 401 before retirement.
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You Will Eventually Be Required To Take Money Out Of Your 401
If you decide not to tap into your 401 early, there will come a time when you will be forced to start taking distributions. Once you turn 72, you must take required minimum distributions . Just like you owe penalties for taking money out of your 401 early, you will owe penalties if you fail to take RMDs and leave money in your 401 too long.
Ultimately, a solid plan for retirement will show you how to use your savings and other financial tools to generate enough money to live comfortably for the rest of your life. A financial advisor can work with you to build a plan that can allow you to generate reliable income for as long as you live.
This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation. All investments carry some level of risk including the potential loss of all money invested.
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Alternatives To A 401 Early Withdrawal
As we mentioned, a 401 early withdrawal can be used in a financial emergency, but it shouldnt be your first choice. The good news is there are plenty of other options available to you.
There are several alternatives to an early withdrawal from retirement, however, most of them mean going into debt, Woodward said. The only difference is your credit will not be used in determining your eligibility for a 401 loan. Your credit will be used for credit cards , HELOCs, personal loans, and any other type of loan.
Your creditworthiness is a major factor when youre borrowing money. Some of the options below may only be available if you have good credit. In other cases, a poor credit score could make the loan cost-prohibitive.
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What Exactly Qualifies As A Hardship Withdrawal
Financial withdrawals are permitted when a certain event is in a dire need of financial aid. For example, emergency medical procedures fall into this category. The amount that you borrow must be used entirely to cover said hardship. In these circumstances, you wont have to pay any early withdrawal penalties, but youll still have to deal with the taxes.
Special Rules Resulting From The Coronavirus Pandemic
It should be noted that the CARES Act of 2020 gave employers the option to amend their 401 plans only if they so choose to allow investors who are impacted by the coronavirus to gain access to of their retirement savings without being subject to early withdrawal penalties and with an expanded window for paying the income tax they owe on the amounts they withdraw per The Security and Exchange Commissions Office of Investor Education and Advocacy .
An employer could amend their plan by allowing coronavirus-related distributions but not increasing the 401 loan limit, according to Porretta.
The SECs OIEA guidance on the CARES Act allowed qualified individuals impacted by the coronavirus pandemic to pay back funds withdrawn over a three-year period , and without having the amount recognized as income for tax purposes.
For income taxes already filed for 2020, an amended return can be filed. The 10 percent early withdrawal penalty was also waived for withdrawals made between Jan. 1 and Dec. 31, 2020. It also waived the mandatory 20 percent withholding that typically applied.
The Act also allowed plan participants with outstanding loans taken before the Act was passed but with repayment due dates between March 27 and Dec. 31, 2020 to delay loan repayments for up to one year. .
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Withdrawing Funds From 401 At 72
If you are age 72, you must start taking annual distributions from the 401, commonly known as required minimum distributions . You must take the first distribution by April 1 of the year you turn 72, and thereafter, you will be required to take the annual withdrawals by December 31 each year. If you delay in taking the first distribution, you must take two distributions in the same year, which will push you to a higher tax bracket. If you miss taking a mandatory distribution, the IRS imposes a 50% penalty on the amount you were required to take during the specific period.
An exemption to the RMDs is if you are still working. To qualify for this exception, you must not own 50% or more of the employerâs company. You can use this exception to delay taking the mandatory distributions until when you stop working.
High Unreimbursed Medical Expenses
This particular exception is similar to the hardship distributions mentioned earlier, and these medical bills might qualify you under either category. You should know that a hardship withdrawal for medical bills will not entitle you to a waiver of the 10% penalty in all cases. To qualify for a penalty-free withdrawal, the amount of the bills must be greater than 7.5% of your adjusted gross income . You must also take the distribution in the same year in which the bills were incurred. You cannot take money for estimated future bills either. The bills must be currently due for services already provided.
Also note the requirement that the bills be unreimbursed. If your insurance covers part of the bills or will reimburse you for the payments, then you cannot use money from your 401 to pay them. Likewise, the bills must be for you, your spouse, or a qualified dependent. You cannot use the money to pay bills for a parent, sibling, or any other family member. The limit to the amount of money you can withdraw for medical bills was recently removed, so you are allowed to withdraw as much as is needed to cover all the expenses.
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Risks Of A 401 Early Withdrawal
While the 10% early withdrawal penalty is the clearest pitfall of accessing your account early, there are other issues you may face because of your pre-retirement disbursement. According to Stiger, the greatest of these issues is the hit to your compounding returns:
You lose the opportunity to benefit from tax-deferred or tax-exempt compounding, says Stiger. When you withdraw funds early, you miss out on the power of compounding, which is when your earnings accumulate to generate even more earnings over time.
Of course, the loss of compounding is a long-term effect that you may not feel until you get closer to retirement. A more immediate risk may be your current tax burden since your distribution will likely be considered part of your taxable income.
If your distribution bumps you into a higher tax bracket, that means you will not only be paying more for the distribution itself, but taxes on your regular income will also be affected. Consulting with your certified public accountant or tax preparer can help you figure out how much to take without pushing you into a higher tax bracket.
The easiest way to avoid these risks is to resist the temptation to take an early 401 withdrawal in the first place. If you absolutely must take an early distribution, make sure you withdraw no more than you absolutely need, and make a plan to replenish your account over time. This can help you minimize the loss of your compound returns over time.
Cashing Out Your 401 After Leaving A Job
LAST REVIEWED Feb 18 20219 MIN READ
Based on the amount of money in your 401 account, your employer may allow you to leave the account with them. However, you will not be able to contribute any more to your old account.
Leaving your account with the old employer may not be prudentespecially when you have access to more flexible Individual Retirement Account plans from most brokers. You may roll over your 401 account to your new employer or transfer the funds into an IRA. If you meet the age criteria, you may start taking distributions without having to pay any penalty for early withdrawal.
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What About 401 Hardship Withdrawals
401 loans are not to be confused with 401 hardship withdrawals. A hardship withdrawal isnt a loan and doesnt require you to pay back the amount you withdrew from your account. Youll pay income taxes when making a hardship withdrawal and potentially the 10% early withdrawal fee if you withdraw before age 59½. However, the 10% penalty can be waived if you can provide evidence that the money is being used for a qualified hardship, like medical expenses or if you have a permanent disability.
Another key difference between the two is that with 401 hardship withdrawals, you would be unable to pay yourself back what you took from your account. This is not the case with 401 loans.
The qualifications for a 401 hardship withdrawal depend on your plan and the rules of plans administrator, so make sure to check to see how you can qualify for one.
Understanding The Rules For 401 Withdrawal After 59 1/2
LAST REVIEWED Apr 15 20219 MIN READ
A 401 is a type of investment account thats sponsored by employers. It lets employees contribute a portion of their salary before the IRS withholds funds for taxes, which allows interest to accumulate faster to increase the employees retirement funds. Now, if you have a 401, you could pay a penalty if you cash out your investment account before you turn 59 ½.
Heres some more information about the rules you need to follow to maximize your 401 benefits after you turn 59 ½.
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Withdrawing Funds From A 401 At 55
The rule of 55 allows 401 participants to withdraw money from the retirement plan penalty-free at age 55. The IRS requires that an employee must have left their employer, either by being laid off, fired, or simply quitting, in the calendar year they turn 55 to get a penalty-free distribution. If you lost your job at 54, you do not qualify to withdraw money tax-free from the 401 when you attain age 55.
The Rule of 55 does not apply to the old 401s left with former employers it only applies to the current 401 with your current employer. If you still have money in the old 401s of a former employer, and you were not yet 55 when you left, the rule of 55 does not apply. You will have to wait until you are 59 ½ to start taking withdrawals from the old 401s without paying a penalty tax. Still, you can roll over the old 401s into your current 401 before you are 55 so that you can take a distribution penalty-free.
Alternatives To Withdrawing From 401
How can you access cash without withdrawing or borrowing from your 401? If you’re a homeowner with equity, you can consider a cash-out refinance, home equity loan or home equity line of credit . All three of these options typically come with competitive interest rates because the financing is secured by your home.
Permanent life insurance policies with cash value components are another option. In this case, your death benefit serves as collateral for the loan. Once the loan balance is paid off, your death benefit is restored in full.
To avoid the penalties from an early withdrawal, consider how much money you’re really looking for. You may be able to make up some extra cash by refinancing your student loans, particularly if you paid high interest rates when you took out the loan.
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How To Cash Out Your 401k And What To Consider
Scott Steinberg4-minute readMay 18, 2021
One of the surest ways to create a comfortable retirement for yourself is to begin saving early on in your career. A 401 plan a type of financial contribution plan which allows you to put a percentage of your salary into an account whose investment gains remain tax-free until funds are withdrawn presents one of the most popular vehicles for doing so. Even better, employers will often match the amount of money set aside up to a certain amount, effectively guaranteeing you free income.
However, in the event that access to money is needed, especially in the wake of a large or unexpected expense, its not uncommon to wonder how to cash out your 401 as well. Here, well take a closer look at the process of cashing out a 401 early, how long it takes to get access to money, and the pros and cons of doing so, including how much early withdrawal before retirement may cost you.
What Are The Hardship Rules For 401 Withdrawal
The rules can vary by plan, and plan participants should always consult their plan documentation to see the specific rules that will apply. Remember that even with a solo 401, you should have your rules written down and documented. However, there are a couple of basic rules that will always hold true when it comes to a hardship 401k withdrawal. First, the withdrawal must be for an immediate and heavy financial need. Next, you are only allowed to withdraw enough funds to cover that immediate need. For example, missing a mortgage payment typically does not qualify as an immediate and heavy need. However, if you have received foreclosure papers and are in danger of eviction, then that constitutes an immediate and heavy need. Again, you should contact your plan administrator with any questions about the hardship requirements for your qualified plan.
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What Is A 401 Plan
Traditional 401 plans are employer-sponsored retirement accounts. They allow you to contribute pre-tax earnings through automatic payroll deductions. Employers can also contribute to your account by matching your contributions or making non-matching donations.
Your 401 account balance grows over time, not only from contributions but thanks to interest yields. However, the Internal Revenue Service restricts how much you can contribute each year and when you can take penalty-free distributions.
If you’re looking to explore retirement accounts besides the traditional 401 it may also be worth considering an IRA.
