Helpful In Other Years: Bipartisan Budget Act Changes
There is other good news about accessibility: The Bipartisan Budget Act passed in January 2018 issued new rules that will make it easier to withdraw a larger amount as a hardship withdrawal from a 401 or 403 plan:
An additional change for 2019 was that you are no longer required to take a plan loan before you become eligible for a hardship distribution. However, whether or not you will be allowed to take a hardship distribution is a decision that still remains with your employer. Your employer may also limit the uses of such distributions, such as for medical or funeral costs, as well as require documentation.
Although a hardship withdrawal might be eligible to avoid the 10% penalty, it still incurs income taxes on the sum you withdraw.
Because You Asked: How Long Does It Take To Cash Out 401k After Leaving Job
Not every job works out the way you might have hoped. Whatever your reason is for looking for a new employer, you’re probably wondering about cashing out your 401 k from your old job if you’re quitting before you reach retirement age. Depending on your individual retirement account, this may involve penalties.
This article discusses how long it might take for you to cash out your 401 k once you’ve left your job. It also goes over your possibilities for doing so and the different types of 401 k account you can have. If you don’t want to cash out the old account, you can generally transfer the money to a new 401 k plan or IRA account. It would help if you decided this based on any potential penalties and your investment options.
Tip No : Avoid Taking Out A 401k Loan
Most employers with a 401k plan allow employees to take out a 401k loan. Whether you need that loan to purchase a primary residence, you are within your rights to receive the loan.
A 401k loan is is different from a bank loan ormortgage loan, simply because there is no lender involved, there no application, no credit checks and all that good stuff.
It is simply a loan where you can withdraw a certain amount of money on a tax free basis, provided that you repay that money according to the rules set by your 401k plan.
However, a loan from your 401k can prevent you from reaching the one million dollars mark. The money you take out is not invested, which means your account wont grow as it would have if you hadnt taken it out the loan.
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How To Get Money Out Of A 401
Youve done a good job of saving money, but nobody ever explained the process of taking money out of a 401. If youre like most people, the priority has been adding funds.
Your ability to get money out of a 401 depends largely on two factors:
You might want to pull your money out for several reasons, including:
- Youve stopped working at the company and youre going to roll your funds elsewhere
- Youre unhappy with the plan and the investments available
- You need the money for bills, medical expenses, or an emergency
- Youre going to use the funds elsewhere
Your reason for pulling money out of a 401 can be important. With certain optionslike the hardship distribution described belowyou may need to qualify. So keep that in mind as you read through the options.
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.
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Taking 401 Distributions In Retirement
The 401 withdrawal rules require you to begin depleting your 401 savings when you reach age 72.
At this point, you must take a required minimum distribution each year until your account is depleted. If you are still working for the employer beyond age 72, you may be able to delay required minimum distribution until you stop working if your plan allows this delay. The delay option is not available to you if you own 5% or more of the business.
You have until April 1 of the year after you turn 72 to take your first required minimum distribution. After that, you must take a minimum amount by December 31 each year. Your 401 plan administrator will tell you how much you are required to take each year.
The amount is based on your life expectancy and your account balance. If you dont take your required minimum distribution each year, you will have to pay a tax of 50% of the amount that should have been taken but was not. If you participate in more than one employer plan, you must take a required minimum distribution from each plan.
You May Need To Take Money Out Of A 401 Here’s What You Need To Know
401s are incentivized plans to help Americans save for retirement. The government provides tax breaks to encourage you to contribute, but it also enforces certain rules to discourage you from taking distributions before retirement. In some cases, breaking those rules and taking distributions early can cost you a 10% penalty in addition to the ordinary income taxes you’ll owe on withdrawn funds.
Let’s look at all the approved ways you can take money out of a 401 and look into the penalties you’ll incur if your early distributions don’t fall within one of those exceptions.
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Three Consequences Of A 401 Early Withdrawal Or Cashing Out A 401
Taxes will be withheld. The IRS generally requires automatic withholding of 20% of a 401 early withdrawal for taxes. So if you withdraw $10,000 from your 401 at age 40, you may get only about $8,000. Keep in mind that you might get some of this back in the form of a tax refund at tax time if your withholding exceeds your actual tax liability.
The IRS will penalize you. If you withdraw money from your 401 before youre 59½, the IRS usually assesses a 10% penalty when you file your tax return. That could mean giving the government $1,000 of that $10,000 withdrawal. Between the taxes and penalty, your immediate take-home total could be as low as $7,000 from your original $10,000.
It may mean less money for your future. That may be especially true if the market is down when you make the early withdrawal. If you’re pulling funds out, it can severely impact your ability to participate in a rebound, and then your entire retirement plan is offset, says Adam Harding, a certified financial planner in Scottsdale, Arizona.
Youll Still Need To Be Mindful Of Taxes
Youll still owe income tax on your distribution from any tax-deferred retirement account. However, if you pay the distribution back within three years, you can file for a refund of the taxes you paid on that distribution.
Also worth noting: The income can be claimed all at once in 2020 for tax purposes, or spread evenly over the next three years. In many cases, dividing it evenly over three years may result in a better tax situation, as its less likely to bump you into a higher tax bracket in any single year.
If your income is expected to be lower in 2020 than the subsequent two years, though, it could make sense to claim all of the income on your 2020 tax return. Not only might this minimize the effective tax rate you pay on this income, but youll also have two years to pay back the distribution and ultimately get a refund.
Keep in mind that if you have a Roth IRA, it may still be a better choice for withdrawals than your 401 or IRA. Thats because savers can always withdraw contributions from their Roth IRA penalty- and tax-free.
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What Happens To Your 401k When You Leave A Job
Unfortunately, many people choose not to make a decision about what to do with their 401k funds. Instead, they simply leave the funds behind in their former employers 401k plan. Most plans allow former employees to leave funds in their account if the account contains more than $5,000. If theres less than $5,000 in the account, the plan sponsor may issue the former employee a check in order to close out the account.
While leaving money behind in a former employers 401k might be the easiest thing to do, its not always the best option. People often fail to monitor accounts held at former employers as closely as they should the money becomes out of sight, out of mind. This problem can worsen if an individual ends up leaving money behind in several different former employers 401ks.
Also, the main benefit of a 401k plan is an employer match if the company offers one. Once you leave a job where you have a 401k, you no longer receive the match. And there are better investment vehicles out there 401k plans tend to have high fees, limited investment options, and strict withdrawal rules. So if youre no longer receiving the match, its usually best not to leave your assets languishing in an old 401k.
Weighing Pros And Cons
Before you determine whether to borrow from your 401 account, consider the following advantages and drawbacks to this decision.
On the plus side:
- You usually dont have to explain why you need the money or how you intend to spend it.
- You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.
- The interest you repay is paid back into your account.
- Since youre borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.
On the negative side:
- The money you withdraw will not grow if it isnt invested.
- Repayments are made with after-tax dollars that will be taxed again when you eventually withdraw them from your account.
- The fees you pay to arrange the loan may be higher than on a conventional loan, depending on the way they are calculated.
- The interest is never deductible even if you use the money to buy or renovate your home.
CAUTION: Perhaps the biggest risk you run is leaving your job while you have an outstanding loan balance. If thats the case, youll probably have to repay the entire balance within 90 days of your departure. If you dont repay, youre in default, and the remaining loan balance is considered a withdrawal. Income taxes are due on the full amount. And if youre younger than 59½, you may owe the 10 percent early withdrawal penalty as well. If this should happen, you could find your retirement savings substantially drained.
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Putting It All Together
So heres how we put this all together.
When youre working, you contribute to your 401 to take advantage of any employer-matched contributions, those sweet, sweet tax deductions, and of course tax-free growth. AND if you happen to work for certain types of companies, you may be able to double your tax-deferred contributions in a process I like to call Double Fisting Your Retirement Accounts.
Over the course of your career, you may end up starting and contributing to multiple 401s.
Then, when you do quit, you roll-over all of them into a Traditional IRA. This is done tax-free.
Now you have a big-ass Traditional IRA. Its full of tax-deferred money you saved over the years, and like a big ol raw pot roast, you want to eat it but you cant. Yet.
So now you start to convert it. Being careful to keep your conversions to within your Standard Deduction of $12k per individual or $24k per married couple, each year on January 1st, you fill out the paperwork with your IRA provider to convert $24k into your Roth IRA.
The next year, you convert another $24k.
You do this for 5 years. On the 5th year, you are now eligible to withdraw that first IRA conversion tax-free and penalty-free!
And so on, and so on.
You may have noticed a certain ladder-like shape to this diagram, which is why this technique is referred to as a Roth IRA Conversion Ladder.
And of course, once you turn the magical age of 59 1/2 , you can stop with this ladder business and just do regular withdrawals.
You Can Roll It Over To A New Ira
If you leave your old job and dont know when youll be starting a new one yet, and you also dont want to leave your 401k with your old employer, you can roll the money over into a new IRA. You can use any financial institution you choose for this. Make sure that your old employer does a direct rollover, signing your money over to the IRA management company, rather than to you, so you can avoid paying the 20% in taxes.
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Max Your Employer Match
Using your full employer match can make the difference between retiring comfortably at 65 and working into your 70s.
Let’s walk through the numbers. Fidelity reports that the average employer matching rate is 4.7% of the employee’s salary. Assuming the match is dollar for dollar, you would contribute 4.7% from your pay and then your employer would also contribute 4.7%. The total contribution rate would be 9.4%.
The U.S. Bureau of Labor Statistics estimates that the average U.S. worker salary is $52,052. A 9.4% contribution rate sets aside about $4,800 annually. If the 401 is earning an average return of 7% after inflation, the balance would grow to about $660,000 after 35 years.
If you contributed only 3%, your annual contributions including the match would be about $3,100. After 35 years with the same 7% growth rate, your ending balance would be $430,000 — or $230,000 lower than the example above.
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Exhausting All Other Options
Investment advisors emphasize that people should exit a 401 only when they deem it absolutely necessary and have exhausted all other options. Remember, the 401 is above all a retirement account. It is wise to consult an investment professional before taking such a dramatic course of action.
“Many employees, as they are exiting their employment through retirement or a job change, rightly seek out advice from financial professionals,” noted Wayne Titus III, who owns AMDG in Plymouth, Michigan. “These may include a range of professions, from insurance agents, brokers, tax preparers, or CPAs.”
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Withdrawing When You Retire
After you reach the age of 59 1/2, you may begin taking withdrawals from your 401. If you leave your job in the calendar year when you turn 55 or later, you can also begin taking penalty-free withdrawals from the 401 you had with that current company. If you are a public safety worker, this rule takes effect at the age of 50.
Once you reach 72, you are actually obligated to begin making required minimum distributions or RMDs.
Key Considerations With 401 Loans
- Some plans permit up to two loans at a time, but most plans allow only one and require it be paid off before requesting another one.
- Your plan may also require that you obtain consent from your spouse/domestic partner.
- You will be required to make regularly scheduled repayments consisting of both principal and interest, typically through payroll deduction.
- Loans must be paid back within five years .
- If you leave your job and have an outstanding 401 balance, youll have to pay the loan back within a certain amount of time or be subject to tax and early withdrawal penalties.
- The money you use to pay yourself back is done with after-tax dollars.
Although getting a loan from your 401 is relatively quick and easy, the benefit of paying yourself back with interest will likely not make up for the return on investment you could have earned if your funds had remained invested.
Another risk: If your financial situation does not improve and you fail to pay the loan back, it will likely result in penalties and interest.
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If Im Eligible Should I Take A Distribution From My 401 Or Ira
Even with the new rules in place, its still advisable to exhaust most other resources, such as emergency funds or other easily accessible forms of savings, before tapping into your retirement accounts.
But if you are considering taking a distribution from your IRA or 401, think through the following first.