How To Withdraw 401K: 401K is offered to the employees in United States for their retirement savings. Under this plan, contribution amount deducted from the employee’s paycheck before taxation. For withdrawing money from 401k the employee must have an age of 59.5 years. In case of any hardship, the funds can be accessed earlier than the defined age (which is 59.5 years) but in this case employee is subjected to 10% penalty if he/she trying to withdraw money from 401k on earlier basis. Generally two options occur when you withdraw from 401K, option (1) – withdrawing before age of 59.5 years; option (2) – withdrawing after age of 59.5 years.
Option 1 – Withdrawing 401K Before Age of 59.5 Years
401k provides a source of retirement income which can be useful for an employee when he gets retired, withdrawing money from 401k before an age of 59.5 years or before getting retired causes some IRS (Internal Revenue Service) consequences such as 10% penalty. In some cases where hardship exists, penalties are not considered for example, excessive medical bills or any emergency expenses. Early withdrawals are not only limited to 10% penalty infect you are also interrupting the wealth compounding effect of time and contributions and also thousands of potential retirement funding can be lost even if you are withdrawing before one or two years.
Some options are available if you want an early withdraw before an age of 59.5 years without any penalty and while you are still employed which can be helpful to meet your expenses:
- Loan – Loan option should be offered by your plan if you want to borrow funds from your 401k which provides access to funds without actually withdrawing. Borrowing and repaying funds is much more convenient for you than to take a distribution and pay the penalty and taxes due. These loans should be repaid within the five years period.
- 72T Rule – Withdrawing without penalty under IRS rule 72T allows you to withdraw money based on your expected life expectancy which ensures that the received contribution will not lead to depletion of your account. Under this rule, withdrawals are made for at least five years or until you reach an age of 59.5 years but you need to pay tax on the money withdrawn.
- Hardships Withdrawals – If you ever face any emergency than you can withdraw money from your 401k without being subject to 10% early withdrawal penalty but taxes will be still due on these early withdrawals. This is known as “Hardship Withdrawal”. In this case it is important to prove that emergency situations are valid. For example, you are buying a home or you are paying college fees for yourself or your family.
- Rollover the Funds – The non-hardship withdrawals are allowed in form of fund rollovers by some of the employers. In this option money is withdrawn from your 401k and than redistributed to any other account such as an Individual Retirement Account (IRA) without tax. Once the funds are rolled over you might face fewer restrictions due to fewer administrative constraints.
Pros & Cons
- You can withdraw money before an age of 59.5 years from your 401k in case of any hardships exception and don’t need to pay for any penalties.
- There are various options in which you can withdraw money before retirement without getting imposed by 10% penalty such as borrowing funds or taking loans on the basis of your 401k.
- The main disadvantage of withdrawing from 401k before retirement age is to pay 10% penalty.
- In case of hardship, if you early withdraw from your 401k than tax is imposed on these withdrawal.
- Instead of cashing out from 401k before an age of 59.5 years you can borrow loans from your account or rollover your funds.
- Every single detail is important but is complex and difficult so discussion is required with your financial adviser.
- You must know, who your plan administrator is if you are not sure as he/she plays a major role.
Option 2 – Withdrawing 401K After Age of 59.5 Years
The age considered for minimum distribution is 59.5 years and it is then when you can withdraw from your 401k without subjecting to 10% penalty on early distribution. As contributions were tax-deferred (i.e. when a taxpayer delays payment of taxes to future period) so the withdrawals will be taxed at the current income rate. After you reach an age of 59.5 there are several ways for withdrawal and these ways depend on your goals and your financial situations.
The plan administrator plays a vital role as any withdrawal activity needs to be discussed with him/her. The plan is usually managed by a third-party financial institution and the plan administrator is a link between you and your plan. You can contact them to discuss options for creating lump sum distribution withdrawals, purchasing an annuity or rolling over your 401k and they can also share helpful guidance for the next step.
- Lump Sum Distribution – It is a form of payout for 401k and is referred to a payout you can take as taxable income. Take into consideration that total withdrawal and payment of taxes rarely makes financial sense for most people unless your lump sum is low.
- Purchasing Annuities – Purchasing annuities is a means of receiving an income for the rest of your life without worrying about how the source of income is invested. Annuities allow you to exchange your 401k for a guaranteed income which is effective for individuals who are worried about exhausting their savings.
- Rolling Money into Traditional IRA – A rollover into IRA (Individual Retirement Account) refers to the process of moving assets from 401k into a Traditional IRA. For rolling money into IRA you just need to contact the company that holds your 401k plan or your plan administrator. An IRA allows you greater access to a wider range of investments. The investments in traditional IRA’s are tax-deductible and if your 401k contributions are pre-tax then the rollover is quite simple. Rollover can be direct (from one plan to the other) or indirect (when plan administrator sends you funds directly). The major providers of IRA are Vanguard and Fidelity.
- Rolling Money into Roth IRA – With this type of IRA, contributions are made on money for which taxes are already paid and your money potentially grows tax-free, with tax-free withdrawals in retirement. Select the best Roth IRA plan and open your account. Consider that 401k transfers of tax-deferred fund will trigger tax if rolled into Roth IRA.
- Doing Nothing – After reaching an age of 59.5 years if you don’t want to do anything with your 401k savings and willing to continue your work providing that you are not retiring, then you can continue investing tax free funds in 401k plan but you cannot withdraw from the plan until you are 70.5 years old.
Pros & Cons
- After an age of 59.5 years the 401k is an essential source of income for you and it is designed to help you financially.
- The biggest advantage of withdrawal from 401k is access to your money. And you don’t need to depend on anybody for your expenses, it’s your money and you can do anything with it.
- For withdrawing from 401k your age must be 59.5 years or more, otherwise you will be charged with 10% penalty.
- The small pieces of details of your 401k account are often quite complex and difficult to negotiate yourself therefore guidance of financial adviser is required.
- You must always know who your “plan administrator” is, as he/she is the connection between you and your 401k plan.
- Withdrawing from 401k is more beneficial after an age of 59.5 years as it will help you in saving for your future use after you get retired.
Some Extra Points
Cashing Out Your 401K from Previous Employer
Thousands of employees change their jobs everyday but the main thing to be keeping in mind is the employee’s 401k. An employee can either cash out their 401k or they can transfer funds into rollover IRA, though the later one helps employee to save more money. Cashing out 401k from previous employer is simple. You only need instructions from previous employer how to do it.
Individual Retirement Account (IRA)
An IRA is an account which is set up at a financial institution that allows you to save your retirement with tax-free growth or on a tax-deferred basis. It helps in saving for retirement in a tax-advantaged way. There are three main types of IRAs and each has their different advantages:
- Traditional IRA – It is a way to save for your retirement that gives you tax advantage. Contributions made to traditional IRA can be fully or partially deductible which depends on your circumstances. Generally, the amount in traditional IRA is not taxed until distribution.
- Roth IRA – In this type of IRA you make contributions with money you have already paid taxes on and your money may potentially grow tax-free, with tax-free withdrawals in retirement under certain conditions.
- Rollover IRA – It is just an IRA retirement account in which 401k funds can be transferred to when you are switching employers by changing one job to the other.
Instead of cashing out your 401k when switching from one job to another, we can opt for another option such as a “Rollover IRA” which is more beneficial as it helps to save more and reduce the chances of penalty. A Rollover IRA is just an IRA retirement account that 401k funds can be transferred to when you are switching job.
Apart from financial advantages Rollover IRA provides an additional advantage i.e. they are easy to set up. All that is required to set up is to pick a company you want to have an IRA with and then simply contact them about setting up a Rollover IRA. They will give the necessary guidance about the process and do the processing on their end. Few companies that set ups Rollover IRA are:
- TD Ameritrade
Advantages of 401K
There are many advantages of saving for retirement by 401k but the main advantage is you can save and invest for your own future. Some other of advantages includes:
- Most of your plan’s investment choices are managed by professionals.
- A company match can help your investments grow.
- You can increase your take home pay as amount contribution percentage is up to you.
- Account services keep you informed.
- Automatic payroll deduction makes it easy to save.
- Your money can go with you, job to job.
Withdrawal Procedure of 401K
- All you need to contact your company’s HR department; they will give you all information about the 401K withdrawal procedure and formalities.