Withdrawing from Your 401k Early (If You Absolutely Have To)
With more people suffering financial hardships under the weight of a sluggish and unforgiving economy, the temptation to tap into 401k plans to meet current obligations is becoming too much to avoid. For many people, it represents their only “liquid” asset, at least to the extent that their money is accessible if they really needed it. While your 401k plan may include some penalty exceptions, they’re not very accommodating for most people who may just need one-time withdrawal to cover some bills.
401k Plan Withdrawal Rules
Separation from Service: If you leave your employer for any reason and start taking withdrawals after the age of 55 you may be exempt from the 10% penalty. It is recommended that you don’t roll your 401k plan into an IRA until after the age of 59 ½ because you could be subject to its 10% early withdrawal penalties.
Substantially Equal Periodic Payments (SEPP): You are allowed to take withdrawals if they meet one of the SEPP requirements. Essentially, SEPP requires that you divide up your 401k balance and take withdrawals as equal installments for a specific period of time. One requirement is that you is that you take your withdrawals in equal installments for a period of five years or until your reach the age of 59 ½ whichever is longer. Another method has you take them over your lifetime. Each method has specific calculations and requirements that, if not met, could result in a retroactive 10% penalty, so it is advisable to seek the guidance of a tax professional.
Qualified Domestic Relations Order: If you to tap into your 401k to satisfy a divorce decree, you can do so without incurring a penalty.
Medical Expenses: If you are incurring medical expenses, you can use your 401k funds to the extent that your expenses exceed 7.5% of your adjusted gross income.
Disability: If you are disabled for a long period of time as a result of an accident or an illness and cannot perform the duties required of your employment or any similar type of work, you can withdraw 401k funds without penalty. You will need to prove that you are disabled.
Military Reservists: If you are a member of the military reserve, you may be able to take early withdrawals if you are called to active duty of a minimum of six months.
If You Have to Take a Withdrawal
The first thing you should do when considering taking withdrawals from your 401k is to reconsider. It should only be done as a last resort. It may be less expensive to borrow the funds especially it is to cover short term needs. Secondly, if you think you may find yourself in that position, you should check with your employer to see what limitations or requirements are attached to its plan. While you are doing that, you should find out if your employer’s plan allows for 401k loans. This can be a much less expensive way to go, but there are requirements and limitations attached as well. For instance, you are required to repay the loan within five years. Plus, you must remain with your employer throughout the duration of the loan. The interest rate is typically fairly low, and the interest you pay is paid to your account. Not all plans allow for loans, but if they do, it may be more preferable than taking a taxable withdrawal and losing a part of your gains to penalties.