Eligibility For Cashing Out A 401 Plan
No advice you receive on how to cash out 401 accounts will matter if your plan doesnt allow it. Yes, some employers wont let you take the money out. Even if your employer does, there could be restrictions on how the money can be withdrawn. You probably have some type of documentation with your 401 that you can check. If not, ask your HR department to provide your policy documents. You can always take money out of plans youre not participating in anymore e.g. a plan at an old employer.
If youre 59 and ½ years old, though, none of that matters. You can take money from your 401 starting at age 59 and ½ without paying a penalty. If you havent yet celebrated your 59th birthday, you may prefer instead to take a loan against your 401 if your employer allows it. This will help get you through your financial situation while still ensuring the money is there when its time to retire.
It’s important to note that the tax man may still come calling, even if you dont pay a penalty. Traditional 401 plans are taxed when you take the money out, while Roth 401 accounts hold funds that youve already paid taxes on. If you have a Traditional 401, youll need to prepare to pay taxes on the money, whether you withdraw it at age 24 or 84. If you have a Roth 401, you can take your contributions out at any time since youve already paid taxes on them, but youll pay taxes on any earnings you withdraw early if youre under 59 and ½.
How Do You Take A Withdrawal Or Loan From Your Fidelity 401
If you’ve explored all the alternatives and decided that taking money from your retirement savings is the best option, you’ll need to submit a request for a 401 loan or withdrawal. If your retirement plan is with Fidelity, log in to NetBenefits®Log In Required to review your balances, available loan amounts, and withdrawal options. We can help guide you through the process online.
Should You Cash Out Your 401k Before Divorce
Rember that withdrawals from a 401K prior to age 59.5 are subject to a 10% early withdrawal penalty. The withdrawal will be reported as income on your tax return. If the withdrawal happens before the divorce is final, the owner is responsible for the taxes and penalties unless you negotiate otherwise. If you are cashing out a portion of the 401K for the non-owner spouse, wait until after the divorce is final and do it through a QDRO so you can avoid the 10% penalty.
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Withdrawing From A 401
The first and least advantageous way is to simply withdraw the money outright. This comes under the rules for hardship withdrawals, which were recently made a little easier, allowing account holders to withdraw not just their own contributions, but those from their employers. Home-buying expenses for a “principal residence” is one of the permitted reasons for taking a hardship withdrawal from a 401.
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You owe income tax on the withdrawal.
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The withdrawal could move you to a higher tax bracket.
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If you are younger than 59½, you also owe a 10% penalty on the money you withdraw.
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You can never repay your account and lose years of tax-free earnings on the money you withdraw.
If you withdraw money, however, you owe the full income tax on these funds, as if it were any other type of regular income that year. This can be particularly unappealing if you are close to a higher tax bracket, as the withdrawal is simply added on top of the regular income. There is a 10% penalty tax, also known as an early withdrawal penalty, on top of that if you are under 59½ years of age.
401 plans do not have a first-time homebuyer exception for early withdrawals, but IRAs do.
How To Make A 401 Withdrawal And Avoid Penalties
How can you make a 401 early withdrawal? Learn how to avoid the 401early withdrawal penalty by taking a qualified exception or hardship withdrawal.
Michael Schultheiss
Key Takeaways
- Taking an early withdrawal from your 401 plan should be considered a last resort.
- The IRS will typically charge a 10% fee for early withdrawals, on top of regular income tax.
- Under certain circumstances, you can make an early withdrawal without paying the fee.
Your 401 is the backbone of your retirement. Thats why it should be tapped only as a last resort. But what happens if you need to make a 401 withdrawal early?
Ordinarily, the IRS will fine you a tax penalty of 10%. However, there are some circumstances under which you are allowed to take an early withdrawal completely penalty-free.
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Disadvantages Of Closing Your 401k
Whether you should cash out your 401k before turning 59 ½ is another story. The biggest disadvantage is the penalty the IRS applies on early withdrawals.
First, you must pay an immediate 10% penalty on the amount withdrawn. Later, you must include the amount withdrawn as income when you file taxes. Even further down the road, there is severe damage on the long-term earning potential of your 401k account.
So, lets say at age 40, you have $50,000 in your 401k and decide you want to cash out $25,000 of it. For starters, the 10% early withdrawal penalty of $2,500 means you only get $22,500.
Later, the $25,000 is added to your taxable income for that year. If you were single and making $75,000, you would be in the 22% tax bracket. Add $25,000 to that and now youre being taxed on $100,000 income, which means youre in the 24% tax bracket. That means youre paying an extra $6,000 in taxes.
So, youre net for early withdrawal is just $16,500. In other words, it cost you $8,500 to withdraw $25,000.
Beyond that, you reduced the earning potential of your 401k account by $25,000. Measured over 25 years, the cost to your bottom line would be around $100,000. That is an even bigger disadvantage.
Hardships Early Withdrawals And Loans
Generally, a retirement plan can distribute benefits only when certain events occur. Your summary plan description should clearly state when a distribution can be made. The plan document and summary description must also state whether the plan allows hardship distributions, early withdrawals or loans from your plan account.
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If You Are Over Age 59 1/2 But Under Age 72
If you are the beneficiary of your spouses 401 plan and you are over age 59 1/2, but not yet at the required minimum distribution age, you have a few choices:
- You can roll over the account into your own IRA. The potential advantage to this is you will not be required to start distributions until the calendar year after you reach your RMD age of 72 . This option provides additional flexibility because you can withdraw the money if needed, but you won’t be required to withdraw it until you reach your RMD age. You name your beneficiaries with this option. For most people, this is the best option.
- You can leave the funds in the plan. If your spouse was over age 72 and had started their distributions, you continue taking these required minimum distributions each year or you begin taking them when your spouse would have reached their RMD age. The beneficiary designations set up by your spouse continue to apply with this choice.
- You can roll the funds over to a specific type of account called an “inherited IRA.” With an inherited IRA, you take required distributions based on your single life expectancy table. If you desire, you can take out more than this amount, but not less. You name your beneficiaries with this option.
Substantially Equal Period Payments
Substantially Equal Period Payments might be a good option if you need to withdraw money for a long term need. These payments must last a minimum of 5 years or until you reach the normal 401k withdrawal age of 59 1/2, whichever is shorter. For this reason, this is not a good option if you have a short term need like a sudden unexpected expense. You cannot withdraw funds under this method if you still work for the employer through which you have the 401. To calculate the amount of these payments, the IRS recognizes three acceptable methods.
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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.
Youll Owe Tax On Any Distributions
When you put money into a 401, you receive a tax deduction in the current year. When you remove it, youll pay ordinary income tax on any distributed amount. Youre going to owe tax whether you take money out as a 30-year-old or a 60-year-old, so make sure to account for this as part of your tax planning.
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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, and your withdrawal would be subject to a 10% early withdrawal penalty tax in that case.
The age-55-and-up retirement rule won’t apply if you roll your 401 plan over to an IRA. The earliest age to withdraw funds from a traditional IRA account without a penalty tax is 59 1/2.
You might retire at age 54, thinking that you can access funds penalty-free in one year, but doesn’t work that way. You must wait one more year to retire for this age rule to take effect.
What About My Current 401 Can I Access That Money At Any Time
You cannot take a cash 401 withdrawal while you are currently working for the employer that sponsors the 401 unless you have a major hardship. That being said, you can cash out your 401 before age 59 ½ without paying the 10% penalty if:
Additionally, you can cash out your 401 and pay the 10% penalty if you need funds for certain financial hardships and have no other source of funds. These hardships include:
Even if you meet these requirements, cashing out your 401 should always be seen as an absolute last resort.
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Dividing Your 401 Assets
If you divorce, your former spouse may be entitled to some of the assets in your 401 account or to a portion of the actual account. That depends on where you live, as the laws governing marital property differ from state to state.
In community property states, you and your former spouse generally divide the value of your accounts equally. In the other states, assets are typically divided equitably rather than equally. That means that the division of your assets might not necessarily be a 50/50 split. In some cases, the partner who has the larger income will receive a larger share.
For your former spouse to get a share of your 401, his or her attorney will ask the court to issue a Qualified Domestic Relations Order . It instructs your plan administrator to create two subaccounts, one that you control and the other that your former spouse controls. In effect, that makes you both participants in the plan. Though your spouse cant make additional contributions, he or she may be able to change the way the assets are allocated.
Your plan administrator has 18 months to rule on the validity of the QDRO, and your spouses attorney may ask that you not be allowed to borrow from your plan, withdraw the assets or roll them into an IRA before that ruling is final. Once the division is final, your former spouse may choose to take the money in cash, roll it into an IRA or leave the assets in the plan.
A Bank Or Credit Union Loan
With a decent credit score you may be able to snag a favorable interest rate, Poorman says. But favorable is relative: If the loan is unsecured, that could still mean 8%12%. If possible, secure the loan with some type of asset to lock in a lower rate.
Interest is the price of borrowing money. Learn how interest rates work.
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How To Avoid Taxes On Your 401 Withdrawals
A 401 plan is a powerful tax-advantaged tool for retirement savers. Employer matches offered by some plans make them even more potent. However, except in special cases you cant withdraw from your 401 before age 59.5 Even then youll usually pay a 10% penalty. Its even harder to tap 401 funds without paying regular income tax. However, there are strategies for getting some access to funds without triggering distribution taxes and penalties. If youre curious about your 401 withdrawals, it may also be a good idea to talk to a financial advisor. Try using SmartAssets free advisor matching tool to find advisors that serve your area.
What To Ask Yourself Before Making A Withdrawal From Your Retirement Account
Retirement may feel like an intangible future event, but hopefully, it will be your reality some day. Before you take any money out, ask yourself an important question:
Do you actually need the money now?
Rather than putting money away, you are actually paying it forward.
If you are relatively early on in your career, you may be single and financially flexible. But your future self may be neither of those things. Pay it forward. Do not allow lifestyle inflation to put your future self in a bind.
Try to think of your retirement savings accounts like a pension. People working towards a pension tend to forget about it until they retire. There is no way they can access it before retirement. While that money is locked up until later in life, it becomes a hugely powerful resource in retirement.
Consider contributing to a Roth IRA, if you qualify for one.
Because contributions to Roth accounts are after tax, you are typically able to withdraw from one with fewer consequences. Some people find the ease of access comforting.
Keep a few factors in mind:
- There are income limits on contributing to a Roth IRA.
- You will still be taxed if you withdraw the funds early or before the account has aged five years.
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