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5 Steps You Can Take To Avoid Penalties On Early 401K Withdrawals

Imagine this scenario for yourself: you’ve just turned 55 and want to withdraw money from your 401(k) plan. Normally, any distribution (other than specifically-qualified distributions) prior to age 59½ would result in a 10% early-distribution penalty. But is there a way to take a distribution at age 55 without racking up penalties? Is there a hall pass for your 401(k)? The short answer is maybe. The definitive, long form answer depends on a few factors.

It all starts with the Internal Revenue Code (IRC). Buried within the tedium of the IRC is a provision that allows you to start taking distributions from your 401(k) plan before you reach age 59½. This little-known section of the IRC can be a game-changer for early retirees who happen to fit the requirements. With this rule in mind, many folks are able to jump-start their retirement by taking payouts from their plan without penalty.

One point to note – although we refer to 401(k)’s here, the provisions of the IRC apply to all ERISA-qualified, employer-established defined contribution plans, which include 401(k), 403(b), 501(a), and other plans, including the federal Thrift Savings Plan.

Learn if you’re eligible for the 401(k) Hall Pass:

Now, back to the question at hand. The answer to your personal situation depends on a few things. Take a look at the list of circumstances and their effects below to see where you stand with early distributions from your 401(k) plan.

1. If you’re still working for the company – Here’s how it works: if you are employed by a company and are participating in their 401(k) plan, and you leave your employment at any time during or after the year in which you reach age 55, there will be no penalty for taking distributions from the plan.

The vast majority of 401(k) plans, however, don’t allow regular withdrawals at age 55 while you are still working for the company. A regular withdrawal is a withdrawal that isn’t subject to penalties, and which doesn’t require you to qualify based on special circumstances.

Instead of thinking about regular withdrawals, consider whether you’re allowed to take a 401(k) loan, or whether you qualify for a hardship withdrawal. Some 401(k) plans allow these penalty-free options.

You can also check with your plan administrator to see if they have a special provision that allows for in-service distributions – special distributions that are allowed before a triggering event (like turning a certain age) occurs to make house payments or pay for your children’s education.

2. If you no longer work for the company – So you want to take money out of an old 401(k) plan – meaning a plan from an employer for whom you no longer work. Here, the rules are a little different.

If you left your previous employer during or after the year you reached the age of 55, then you can take a withdrawal. While not subject to the penalty tax, this withdrawal will be considered taxable income. The rule here applies even if you are not yet age 59½.

3. If you left the company before age 55 – Here’s the bad news: if you left your previous employer before you reached age 55 (or age 50 for public safety employees), but are now over 55, the special early withdrawal provision doesn’t apply to you. This means that any withdrawals you choose to take will be subject to the penalty tax. The good news? There are still creative ways to preserve your assets. Look into rolling your 401(k) plan to an IRA to qualify for a penalty exception.

4. If you inherit a 401(k) – If you find yourself as a beneficiary of a 401(k) plan, the rules above won’t apply. Instead, factors like whether you were a spouse, or non-spouse, and the age at death of the 401(k) owner, will determine your particular distribution provisions.

5. Looking to the future – Remember, 401(k) money is protected from creditors. But if you cash in a 401(k) plan early, you will void this protection. So, if you’re in hot water financially, cashing in a 401(k) plan early could be a costly mistake.

Always consider your own personal circumstances before you make any decisions about how to approach retirement plan distributions. For instance, if you plan on retiring very early, say at age 54, it might make sense to wait until the year you reach age 55. This way you’ll have more access to your 401(k) money without the early withdrawal penalty tax.

On the other hand, if you were retiring somewhere between age 55 and 59, for some people it would make sense to leave money in their 401(k) plan until they reach age 59 ½. Using this approach, you have the option of taking withdrawals if you need to, but you don’t dip in unless it’s necessary.

 


Read the original article here.

Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.


 

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