When Can You Cash Out Your 401
There are two occasions when you can cash out your 401:
The bigger question is should you cash out your 401 in either of these circumstances? Youll want to give it careful thought.
When you leave your old employer, you have the option to cash out your 401. This means youll receive a check in the mail. It wont be the full amount of your vested funds, though. Youll face penalties as well as taxes. You can avoid this by rolling the funds over into another 401 or other qualified retirement plan, such as an IRA.
If you are still working for your employer, you cannot withdraw your 401 funds, even if you turn 59½. This is true unless you meet the requirements for a hardship withdrawal. Some employers offer this option, but not all do. Talk with your HR department to see if your company offers it.
A hardship withdrawal means that you can demonstrate an immediate need for funds, which according to the IRA may occur due to the following:
- Immediate medical care expenses of the employee or qualified dependent.
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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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Its Better Than Falling Behind On Your Bills
Sometimes, you just dont have a better option. If a 401 withdrawal is the only way that you can pay your bills without taking on costly credit card debt, do it. Leaving your retirement savings alone isnt worth it if it threatens your current financial security and your ability to save more for retirement in the future.
Only withdraw as much as you need and keep seeking out alternative sources of funding. Look for a new job if youve lost yours, start a side hustle, or consider applying for a personal loan with a reasonable interest rate.
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Why Do People Use Their 401 To Pay Down Debt
Although there are significant costs involved in taking money out of a 401 to pay debt, many people still do it. It can seem like a good option if you have high-interest debt like credit card debt and you have to face those bills every month. If you have lower interest debt like student loans, personal loans, auto loans, or a home equity line of credit , then the early withdrawal penalty and other consequences may be a deterrent.
But if youre paying high interest on your current debt, or if you have debt payments due and no way to cover them, using your 401 might seem better than the risks of missing payments on those bills. Late payments can rack up fees, interest, and can ding your credit score. And if you default on a debt, that can have even more dire consequences, potentially including court actions and wage garnishment depending on the type of debt and the creditor or lender. You cant exactly wait it out and count on winning the lottery or inheriting money from some long-lost relative.
If your credit score ends up damaged due to late payments, that, too, could have a huge impact on your finances. Having a low credit score can make it more difficult to get loans in the future. You might have to pay a higher interest rate or there might be limits on how much you can borrow.
How Much State Tax Do I Pay On 401k Withdrawal
Because payments received from your 401 account are considered income and taxed at the federal level, you must also pay state income taxes on the funds. The only exception occurs in states without an income tax. Your 401 plan may offer you the opportunity to have taxes automatically withheld from a withdrawal.
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Are You Eligible To Withdraw Money From Your 401 To Pay Debt
First, youll have to determine whether you are able to use your 401 savings to pay debt. Your plan administrator and the IRS guidelines are great resources but generally, 401 distributions are allowed if:
- You reach age 59.5
- You die, become disabled or are otherwise withdrawn from the workforce
- Your employer terminates your plan and doesnt replace it with another
- The distribution is related to a financial hardship
That last one is important because not all employers allow hardship distributions from a 401. Even if your plan does allow hardship distributions, you must demonstrate that the funds will address an immediate and heavy financial need. That includes things like:
- Paying medical expenses for yourself, your spouse or your dependents
- Purchasing a principal residence
- Paying tuition, educational fees or room and board for yourself, spouse or dependents
- Avoiding eviction or foreclosure
- Funeral expenses
Keep in mind that every employer is different. Even if your employer allows a hardship distribution, they may not recognize each of these scenarios. In most cases, you wont be able to contribute to your plan within six months of taking a hardship withdrawal.
Withdrawing From A Roth 401k
Most 401k plans involve pre-tax contributions, but some allow for Roth contributions, meaning those made after taxes already have been paid.
The benefit of making a Roth contribution to your 401k plan is that you already have paid the taxes and, when you withdraw the money, there is no tax on the amount gained as long as you meet these two provisions:
- You withdraw the money at least five years after your first contribution to the Roth account
- You are older than 59 ½ or you became disabled or the money goes to someone who is the beneficiary after your death
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What Did The Cares Act Change
The CARES Act allows you to withdraw up to $100,000 from your retirement account penalty-free until the end of 2020. So far, relatively few Americans have taken advantage of this new exemption: The Investment Company Institute reports that less than 3% of retirement plan owners made early withdrawals so far this year.
Home Equity Line Of Credit
Instead of fixed-term repayment, you get a variable repayment and interest rate. You may opt for an interest-only repayment, but most often that comes loaded with a balloon payment, Poorman says, and may be tough to afford. Keep in mind that with a variable interest rate loan, you could see your rates go up over time.
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How Much Tax Do You Pay On Retirement Withdrawals
There is a mandatory withholding of 20% of a 401 withdrawal to cover federal income tax, whether you will ultimately owe 20% of your income or not. Rolling over the portion of your 401 that you would like to withdraw into an IRA is a way to access the funds without being subject to that 20% mandatory withdrawal.
Is Borrowing From A 401 To Pay Off Debt Possible
First and foremost, yes, it is possible to borrow from a 401 to pay off debt. The question is whether or not it is advisable to do so. Typically, your retirement savings should stay in your account until you are old enough to start taking regular distributions. Spending the money before youve reached retirement age may leave you short in your golden years.
In light of that, if you are considering borrowing money from a retirement account to pay off debt, its a good idea to talk to an advisor about your financial goals first. They may recommend temporarily pausing retirement contributions and using the extra income to pay down your debts rather than taking money out of your account. However, the decision is yours to make.
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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. Don’t have either? You can also look into personal loans from a wide variety of online lenders. The better your credit and income, the more competitive offerings you can access.
Do You Have To Pay Taxes On An Ira After 70
All of the money in your traditional IRA belongs to you. … You must begin taking minimum withdrawals from your traditional IRA in the year you turn age 70 1/2. The amount you withdraw at that time is taxed as ordinary income, but the funds that remain in your IRA continue to grow tax deferred regardless of your age.
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How Much Can I Take From My Ira At 59 1 2
There are no restrictions on the quantity or timing of withdrawals from a regular IRA between the ages of 59 1/2 and 70 1/2. You are free to take as much as you want at any time. All distributions between those ages are penalty-free, qualifying distributions. Traditional IRA distributions, on the other hand, are subject to federal income taxes and may also be liable to state taxes.
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Alternatives To Tapping Your 401
If you must tap into retirement savings, its better to look at your other accounts firstspecifically IRAsespecially if youre buying a first home .
Unlike 401s, IRAs have special provisions for first-time homebuyerspeople who havent owned a primary residence in the last two years, according to the IRS.
First, look to take a distribution from your IRAif you have one. You may be able to withdraw IRA contributions without penalty due to a qualified financial hardship. You can also withdraw up to $10,000 of earnings tax-free if the money is used for a first-time home purchase. As a first-time homebuyer, you can take a $10,000 distribution without owing the 10% tax penalty, although that $10,000 would be added to your federal and state income taxes. If you take a distribution larger than $10,000, a 10% penalty would be applied to the additional distribution amount. It also would be added to your income taxes.
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What Does The Irs Consider A Hardship Withdrawal
Hardship distributions A hardship distribution is a withdrawal from a participant’s elective deferral account made because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower’s account.
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How Often Can You Borrow From 401
If your employer allows multiple 401 loans, you can borrow more than one loan at a time. However, any new loan should not exceed the plan loan limit. 401 plans place limitations on borrowing from 401 over a 12-month rolling period. This means that, if you took two loans between February of the previous year and February of the current year, and you have used up the loan limit, you cannot borrow another loan in the same period even if you paid the first loan early. Hence, you will have to wait after the 12-month period to take another loan.
Is Cashing Out My 401k Ever A Good Idea
As a coach, I have found that there are two exceptions to this otherwise rigid rule: avoiding bankruptcy or foreclosure.
Both bankruptcy and foreclosure are extremely heavy burdens to bear. A Chapter 7 bankruptcy will clear ones debts and wipe the slate clean. But the bankruptcy trustee takes away certain assets for liquidation. One may reaffirm certain debts, such as cars, but the debtor still owes the creditors for those debts not liquidated in the Chapter 7.
A Chapter 13 bankruptcy is a three-to-five-year payment plan where the debtor gives a large portion of financial control to the Chapter 13 trustee. It is difficult to do anything during this time, even a debt snowball, so I strongly recommend avoiding bankruptcy in nearly all circumstances.
Foreclosure is also a devastating experience. Imagine losing the home youve lived in for years, made renovations on, and in which you dreamed about raising your family. The foreclosure sweeps that away, wrecks your credit, and uproots stability in your familys life. It can take years to get back to the point of even being creditworthy to get a mortgage again.
Normally, I do not suggest cashing out a 401k to pay off debts. But if your current track is either a bankruptcy, or a foreclosure, or even both, then it may be something to seriously consider only to avoid either of those things from happening.
The cost of the early cash-out is high, but not necessarily as high as bankruptcy or foreclosure.
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Alternatives To Rule Of 55 Withdrawals
The rule of 55, which doesnt apply to traditional or Roth IRAs, isnt the only way to get money from your retirement plan early. For example, you wont pay the penalty if you take distributions early because:
- You become totally and permanently disabled.
- You pass away and your beneficiary or estate is withdrawing money from the plan.
- Youre taking distributions to pay deductible medical expenses that exceed 7.5% of your adjusted gross income.
- Distributions are the result of an IRS levy.
- Youre receiving qualified reservist distributions.
You can also avoid the 10% early withdrawal penalty if early distributions are made as part of a series of substantially equal periodic payments, known as a SEPP plan. You have to be separated from service to qualify for this exception if youre taking money from an employers plan, but youre not subject to the 55 or older requirement. The payment amounts youd receive come from your life expectancy.
What Reasons Can You Withdraw From 401 Without Penalty
So, are there cases in which you can access cash through your 401 without incurring any penalty fees?
You generally need to be experiencing a serious financial hardship in order to qualify to withdraw early from your 401 without penalty. The guidelines are broad to allow for different contingencies, but generally you need to be dealing with major medical expenses or be at risk of losing your house, according to Seuthe.
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Exceptions To The Penalty
The IRS permits withdrawals without a penalty for certain specific uses. These include a down payment on a first home, qualified educational expenses, and medical bills, among other costs.
As with the hardship withdrawal, you will still owe the income taxes on that money, but you won’t owe a penalty.
Keeping Your Money In A 401
You are not required to take distributions from your account as soon as you retire. While you cannot continue to contribute to a 401 held by a previous employer, your plan administrator is required to maintain your plan if you have more than $5,000 invested. Anything less than $5,000 will likely trigger a lump-sum distribution.
If you have no need for your savings immediately after retirement, then theres no reason not to let your savings continue to earn investment income. As long as you do not take any distributions from your 401, you are not subject to any taxation.
If your account has $1,000 to $5,000, your company is required to roll over the funds into an IRA if it forces you out of the planunless you opt to receive a lump-sum payment or roll over the funds into an IRA of your choice.
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