How to Withdraw Money from 401(k) Before Retirement

There are also times when life presents you with financial issues that you might not expect to face and you may be thinking about drawing on your 401(k) retirement funds sooner than you would be anticipating. Perhaps, you have medical bills, you lost your job or other urgent costs that you are wondering what to do. Although your 401(k) is intended to take care of you upon retirement, you can tap into these funds sooner but such actions have significant tax implications and penalties you must be aware of. Being aware of the rules, expenses, and options will allow you to make wise decisions that will not jeopardize your fiscal future but will help you solve the urgent problem. At H&M Tax Group, in Dallas, TX, the experienced team of tax professionals assists our clients in taking the right steps to establish these complex situations in order to be aware of the full tax implications prior to making the withdrawal decisions.

What is the way to access 401 (k) money before retirement?

There are a number of ways to get 401 (k) funds prior to age 59½: direct withdrawals, 401 (k) loans, hardship withdrawals, or exceptions such as the Rule of 55. Direct withdrawals normally invoke income taxes as well as a 10 percent penalty. Loans will enable you to lend to yourself and earn it back with time. The hardship withdrawals are allowed in certain emergencies approved by the IRS. You might be eligible to receive withdrawals penalty-free in case you have left your work place at the age of 55 and above. All of these methods come with rules and implications, and to determine which one would best suit your scenario, it may be necessary to take time to weigh the terms of your plan and personal circumstances.

Popular Early Withdrawal Alternatives.

• Direct distribution: Paying cash, out of your account, taxed and fined.
• 401 (k) loan: Borrowing on your accounts by repayment.
• Hardship withdrawal: Using funds to cover IRS-approved immediate financial aid.
• Rule of 55: 0-penalty withdrawals when you leave your employer at the age of 55 or above.
• SEPP (Substantially Equal Periodical Payments): Planned withdrawals without the 10% early withdrawal penalty under IRS guidelines.
• Rollover to IRA: Rolling money into an Individual Retirement Account that has other withdrawal criteria.

Are there any penalties and taxes charged on early 401(k) withdrawals?

Withdrawals at an early age have high tax implications in 401(k). The whole withdrawal is subject to ordinary income tax on 401(k) distributions which could increase your taxable income and potentially place you in a higher tax bracket. There is also the IRS penalty of an extra 10 percent of early withdrawal penalty in case you are below the age of 59½. In a case scenario, a withdrawal of $10,000 would lead to $2,500 federal tax (25 percent bracket) and a fine of $1,000, and only $6,500 would be left. Income taxes at the state level might also be applicable. Plans usually automatically withhold 20 percent for federal taxes. All these costs make early withdrawals expensive, and this is why proper tax advice from a professional advisor is required before deciding on this move.

IRS Early Withdrawal Penalty Rule.

• 10 percent penalty: Imposed on the majority of distributions that are made below age 591/2.
• Ordinary income tax: The sums withdrawn are included in your taxable income in the year.
• Exception to loans: Unpaid loans in 401(k) are considered as distributions, which are taxable.
• State taxes: There can be an addition of state income tax based on location.
• Withholding requirements: Full 20% is normally withheld by plans as federal tax.
• Form 1099-R reporting: Distributions will be reported to the IRS and will be required to be included in your tax return.

Are there instances in a 401(k) when you can withdraw without penalty?

The IRS does understand that there are certain exceptions under which the 10 percent penalty is not applicable, but common income taxes are nevertheless. These are the total and permanent disability, the unreimbursed medical expenses beyond 7.5 percent of adjusted gross income, health insurance payments during unemployment, the death of the account holder, military reservist deployment, court-order QDRO payments, the rule of 55 (leaving your employer when 55 years old and older), IRS tax levy and the substantially equal periodic payments (SEPP). Every exception has its requirements and documentation requirements. To know whether you are qualified, it is very important to go through it with a tax expert who will check your eligibility and make sure that you comply accordingly.

Total and permanent disability: Inability to work permanently because certified by a physician.

• Unreimbursed medical expenses: More than 7.5 percent of the adjusted gross income.
• Health insurance premiums: During the period of unemployment compensation.
• Death of account holder Beneficiary payments.
• QDRO payments: Payments to former dependents or spouse due to divorce.
• Military reservist deployment: 180+ days of active duty.
• Rule of 55: Retirement upon age of 55 or above.
• IRS levy: Tax collection by IRS.
• Substantially Equal Periodic Payments: SEPP payment under the IRS guidelines.

What is the difference between hardship withdrawals and 401(k) loans?

Hardship withdrawals permanently withdraw money out of your account- you cannot re-pay it and it is immediately taxed as income and it is also usually penalized by the 10% penalty. This plan can limit your future contributions in the short term. A 401(k) loan allows you to borrow half your vested balance, or fifty thousand dollars (whichever is less), and pay it back with interest in 5 years without incurring early taxes and fines. The interest is refunded into your account. You can however pay off your loan in arrears, or default on your employer which is subject to taxed distribution and penalties. The two offer less retirement savings.

Implication on Long-term Retirement Savings.

• Lost growth of investment: Money taken out or borrowed loses growth by interest on the loan.
• Less retirement income: Smaller account balance will result in less money in retirement.
• Opportunity cost: Forfeiting market gains in the course of withdrawal or loaning.
• Contribution limits: There are plans that limit contributions following hardship withdrawals.
• The double taxation on the loan: Repayment of loans to be done using after-tax money, which is taxed again on withdrawal.
• Hard to restore: It is hard to rebuild retirement savings that are lost due to early withdrawal.
• Compounding effect: Minor withdrawals can make a great contribution to the account worth over a long period of time.

Conclusion

An early withdrawal in a 401k is a major financial choice that has both long-term tax and retirement effects. We can offer you the educational advice and structured analysis to know your options at the fullest extent at H&M Tax Group in Dallas, TX. We assist Dallas residents in considering the tax implications of the early withdrawals, possible exceptions of the potential penalties and alternative options that could be more effective to meet your financial needs.