Can’t Wait For Your Retirement Funds Learn How To Get Your Retirement Money Early
If you need to dip into a retirement account — whether it’s a 401, IRA, or something else — before you retire, you will likely pay a penalty. However, there are a few ways to avoid the penalty.
If you take a distribution from your retirement plan early you will generally have to pay a 10% early distribution tax above and beyond any regular income taxes you may owe on the money. That extra 10% might be called a tax, but it looks and feels like a penalty. In fact, the early distribution tax is the cornerstone of the government’s campaign to encourage us to save for retirement — or put another way, to discourage us from plundering our savings before our golden years.
Of course, it’s generally a bad idea to dip into your retirement plan early except in extraordinary circumstances. But when using your retirement funds is your only option, it’s good to know that there are several ways to avoid the extra 10% tax on early distributions.
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
Tips That Will Allow You To Retire Early
Some of this stuff may seem hard, but my father always said, Anything worth doing is going to seem hard at first.
Some of the things you may have heard before, but thats because they are 100% true.
Some of this you may want to pretend doesnt work, but I promise you it does.
1) The first tip is to INVEST EARLY. I have heard this time and time again, but have I put it into practice? Nope.
I dont even really know how to get started.
My husband, who is a confessed nerd, has said for YEARS that we need to invest in a Roth IRA, and this is something that Mia Pham agrees that you should totally do.
Just fill out the form and send it in.
Dont wait until you are older. The earlier you sign up for your Roth IRA, the more time it has to earn interest!
You will find there is magic in the compound interest that your Roth IRA earns.
Invest, Invest, Invest, and then up your contributions. You will eventually be earning money just for having money in your Roth IRA.
2) Mia says she was all set to buy a house when she learned of the FIRE movement.
Then, she got to thinking about the possibility of retiring early, and that big house didnt seem so important.
When we realized that stocks generally outperform real estate except for this pandemic rate we decided to buy a smaller house.
She got a smaller house, and INVESTED THAT MONEY that she would have spent on a larger house.
What does she invest in?
Mia suggests to live below your means. *Sad Face Emoji*
4) PLAN for your retirement.
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Track Your Progress And Hone Your Strategy
Planning for early retirement isnt a set-it-and-forget-it experience. A lot can change, and youll need to continually track your progress and hone your early retirement strategies.
To stay on top of your finances, use a budgeting app, such as:
You may also need to tweak your early retirement plan.
To retire sooner, you could decide to lower your retirement lifestyle budget. In this case, you may not have as much money in retirement, but you could retire earlier.
On the other hand, you could decide to retire later than you had hoped. Although, youll have to work longer, youll have more money when you retire early.
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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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.
What If You Only Need The Money Short Term
Although there are other qualifying exceptions to withdraw IRA or 401k assets penalty-free, those listed above are the major ones. But suppose youre not interested in paying any taxes at all. You can still use your 401k to borrow money via a loan. The interest goes to you, the loan isnt taxable, and it wouldnt show up on your credit report. Heres how it works.
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Withdrawing Funds Between Ages 55 And 59 1/2
Most 401 plans allow for penalty-free withdrawals starting at age 55. You must have left your job no earlier than the year in which you turn age 55 to use this option. You must leave your funds in the 401 plan to access them penalty-free. But there are a few exceptions to this rule. This option makes funds accessible as early as age 50 for many police officers, firefighters, and EMTs.
Make sure to understand the rules around the age requirement for penalty-free withdrawals. For example, the age 55 rule won’t apply if you retire in the year before you reach age 55. Your withdrawal would be subject to a 10% early withdrawal penalty tax in this case.
You might retire at age 54, thinking that you can access funds penalty-free in one year. It doesn’t work that way. You must wait one more year to retire for this age rule to take effect.
The retirement rule regarding age 55 and up won’t apply if you roll your 401 plan over to an IRA. The earliest age at which you can withdraw funds from a traditional IRA account without a penalty tax is 59. 1/2.
Making The Numbers Add Up
Put simply, to cash out all or part of a 401 retirement fund without being subject to penalties, you must reach the age of 59½, pass away, become disabled, or undergo some sort of financial hardship . Whatever the circumstance though, if you choose to withdraw funds early, you should prepare yourself for the possibility of funds becoming subject to income tax, and early distributions being subjected to additional fees or penalties. Be aware as well: Any funds in a 401 plan are protected in the event of bankruptcy, and creditors cannot seize them. Once removed, your money will no longer receive these protections, which may expose you to hidden expenses at a later date.
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Tests For A 401 Hardship Withdrawal
The six tests for a hardship withdrawal did not change with the new law. Hardship withdrawals are permissible due to a heavy financial due to the following:
For 2020, there is an additional reason under the CARES Act: being negatively affected by COVID-19.
From 2018 to 2025, the Tax Cuts and Jobs Act declared such losses are not tax-deductible except in specified federal disaster areas. It should be noted that the Tax Cuts and Jobs Act also reduced the threshold for individuals deducting for medical expenses to those that exceed 7.5% of adjusted gross income for 2017 and 2018. However, that threshold rose back to 10% of AGI, starting in the 2019 tax year.
How To Withdraw From A 401/ira Early And Not Pay A Penalty
Most people are unaware of the available strategies on how to withdraw from a 401, 457, 403, TSP, IRA and not pay the penalty if you want to retire before age 59 1/2.
If youre looking to retire early and youve put enough money away in your 401, one of the most important questions to answer is:
How am I going to pay for my early bird dinners at 4:30 in the afternoon?
You cant collect social security until age 62 . The imperial federal government wants to protect you from going broke by hitting you with a penalty if you take money out of retirement accounts before age 59 1/2.
But smart people like you arent relying on the government to take care of them. And neither should you rely on the government to do your retirement or early retirement planning.
There are ways to take early withdrawals from your 401 without paying the 10% penalty before age 59 1/2. Ill share with you how to do it.
WARNING WARNING WARNING1) broke2) paying huge penalties
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Bankrate follows a strict editorial policy, so you can trust that were putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.
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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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The Risks Of A Rollover
Before people roll over their 401 funds to an IRA, however, they should consider the potential consequences. “Consider the costs inside the 401 funds versus the total cost of an IRA,” including advisor fees and commissions, urges Terry Prather, a financial planner in Evansville, Ind.
Prather raises another, noteworthy scenario. A 401 typically requires a spouse to be named as the primary beneficiary of a particular account unless the spouse signs a waiver provided by the plan administrator. An IRA doesn’t require spousal consent to name someone other than the spouse as the primary beneficiary.
“If a participant is planning to remarry soon and wants to name someone other than the new spouse as the beneficiarychildren form a prior marriage, perhapsa direct rollover to an IRA may be desirable,” Prather says.
Required Minimum Distribution Method
This will result in an annual payment to the recipient. The account balance is divided by the life expectancy factor of the recipient to arrive at the annual amount. The amount is recalculated each year based on the new account balance, but the life table used in the original calculation is used for the duration of the payments.
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Open Your New Ira Account
You generally have two options for where to get an IRA: an online broker or a robo-advisor. The option you choose depends on whether you’re a “manage it for me” type or a DIY type.
If you’re not interested in picking individual investments, a robo-advisor can do that for you. Robo-advisors build personalized portfolios using low-cost funds based on your preferences, then rebalance those funds over time to help you stay on track, all for a much lower fee than a conventional investment manager.
If you want to build and manage your own investment portfolio, an online broker lets you buy and sell investments yourself. Look for a provider that charges no account fees, offers a wide selection of low-cost investments and has a reputation for good customer service.
» Ready to get started? Explore best IRA accounts for 2021
What You Need To Know To Avoid Costly Mistakes
In an ideal world, everybody would leave their 401 funds alone until they need the money for retirement. That might mean rolling your account over to an Individual Retirement Account , but it also means not cashing out the funds prior to reaching retirement age, to allow the money to grow to its maximum potential amount. In investing, time truly is your best asset. At some point though, you will begin taking distributions, and here’s what you need to know.
The best way to take money out of your 401 plan depends on three things:
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If Youve Already Taken A Withdrawal Or Loan You Can Recover
Stay calm and make steady progress toward recovery. It can be done. Build up a cushion of at least three to nine months of your income. No matter what incremental amount you save to get there, Poorman says, the key detail is consistency and regularity. For instance, have the sum automatically deposited to a savings account so you cant skip it.
Scale back daily expenses. Keep your compact car with 120,000 miles and drive it less often to your favorite steakhouse or fashion boutique.
Save aggressively to your 401 plan as soon as possible and stay on track. Bump up your 401 contribution 1% annually, until you maximize your retirement savings. Sock away the money earned from any job promotion or raise.
Be Prepared To Change Your Mind About Goals And Interests
While Mamula agrees that preparing for the soft side of retirement is important, he has also found that interests are likely to change and that you should be open to that change!
He said, I put in a lot of thought on the softer side. But what Ive found is, I dont think Im very good at predicting what Im going to want and whats going to make me happy. And I think like research shows thats a pretty common thing actually, that the things that we think are going to make us happy once you achieve them, oftentimes they dont.
And so I think thats just something to be aware of and to think about. And I think theres a lot of value in planning and thinking about these things. But also you have to understand that, as things change, your perspectives change and you might be surprised by what you find on the other side.
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