After working your entire life, you deserve to have a significant nest egg to provide support throughout your golden years. However, there are strict rules regarding 401k accounts and withdrawing your money too soon could leave you facing serious penalties. While it can be tough to view your 401k funds as off limits when immediate needs arise, it is important to understand the 401k withdrawal penalty and how you can avoid these exuberant fees. Learn more about 401k money withdrawal and how financial consultants can assist you with your retirement portfolio.
401k Withdrawal Timing Rules
Rules surrounding retirement plans are put in place to ensure that your funds are readily available when you retire. If you have money saved in a 401k account, you generally cannot withdraw the funds until you have reached age 59 ½, left your employer, have become disabled, or have passed away in which time your beneficiaries must begin withdrawing from the account. However, there are some loopholes to these rules. Most 401k plans allow you to access your money early through certain hardship distributions. However, you can only withdraw funds that you are vested in, or have ownership over.
As the main contributor of your 401k, you are fully vested in the salary deferral contributions that you make while employed. However, any contributions made by your employer through matching or profit sharing contributions may have to follow a vesting schedule. Before these funds can be fully vested, the employer must have had to work for the employer for up to six years. If for whatever reason an employee chooses to leave the employer before he or she is fully vested, any unvested portion of the employer’s contribution is automatically forfeited back to the plan.
Early 401k Withdrawal Penalty
If you find that you absolutely need the funds from your 401k before you reach 59 ½, you may be facing some steep penalties. When you fund a traditional 401k, all contributions made to the account remain tax-free until the time of withdrawal. However, in exchange for this tax break the IRS wants you to leave the money untouched until you reach the designated age. If you attempt to withdraw these funds sooner, you will likely face a 10 percent early withdrawal penalty on the sum of money withdrawn. For example, if you withdraw $20,000 at age 35, you will lose $2,000 as a penalty.
In addition to this steep 401k withdrawal penalty, you will also have to pay any tax due based on your ordinary income tax rate. However, if you are experiencing a hardship the IRS may allow you to withdraw funds early, penalty-free. To be eligible for this perk, you must meet the definition of hardship set by the IRS. Some examples of a hardship may include a death, disability, medical expenses, funeral expenses, education expenses, purchase of a home, housing payments needed, or certain home repair expenses for your primary residence. You must also prove that the funds in your 401k are necessary to satisfy an “immediate and heavy need.”
If you want to avoid the 401k withdrawal penalty, you may be interested in a 401k loan. If your employer permits this option, you can borrow funds from your 401k account with interest. You will then have to repay the loan, as well as any accumulated interest, by increasing the pre-tax deferrals from your paychecks. There are several benefits to using a 401k loan, such as lower interest rates. Unlike other types of loans, a 401k loan does not require a credit check.
When you reach retirement, you may be tempted to take out the full amount all at once. However, this is typically not the best way to approach withdrawal. At retirement, your funds still have the chance to grow, even if you choose to withdraw some funds. It can be beneficial to keep some money in the account to grow. Most experts recommend withdrawing 4 percent annually to maintain financial security. However, how much you need to meet your expenses, your life expectancy, and various other factors should be considered when determining the best rate of withdrawal.
Learn More About 401k Withdrawals
Knowing the best way to handle and withdraw your money from a 401k account can be tricky. By following the rules that pertain to 401k accounts, you can power through your retirement with plenty of funds to cover your expenses. If for whatever reason you are unable to withdraw all of your retirement funds before death, know that any money left in the account is passed onto the beneficiaries you named while opening the account. However, your beneficiaries will be responsible for paying income tax on any funds withdrawn from the account. For more information about 401k withdrawal penalty or for assistance with your retirement portfolio, contact the financial consultants at IFG.