When You Can Make Early 401(k) Withdrawals?

One of the most common retirement investment plans for American workers is the 401(k). The name for these plans comes from their section of the IRS tax code. A 401(k) retirement plan allows you to save for the future and defer income taxes until the time you are ready to start taking distributions. However, this tax-free contribution plan comes with restrictions. This limits when you can withdraw money without financial penalties.

Understand 401(k) rules and regulations so you can get the maximum benefit from your investment. For more information about 401(k) withdrawal requirements and penalties, talk to a local attorney with experience in 401(k) plans.

When Can You Withdraw 401(k) Funds?

There are specific restrictions for withdrawing funds from a 401(k) retirement plan. Generally, there are no financial penalties for withdrawals in the following situations:

• After the age of 59 ½ years old
• You die or become permanently disabled
• The plan terminates and your employer does not identify a successor plan
• You have a financial hardship that qualifies for an exception

If you do not meet any of the withdrawal criteria described above, you are subject to a 10% tax penalty. You also have to pay ordinary income tax on the 401(k) distributions for that tax year.

What Is a Qualifying Financial Hardship for 401(k) Withdrawals?

Hardship withdrawals do not penalize account holders for an early distribution if they are experiencing financial trouble. According to the IRS, a hardship distribution must be based on an immediate and heavy financial need, and the distribution is necessary to satisfy that need.

Examples of hardship distributions include medical expenses, funeral expenses, or to avoid eviction. Even if you qualify for a hardship exemption, there is a limit to how much you can take out. The withdrawal can only be up to the amount necessary to satisfy your immediate financial needs.

When Do You Have to Take 401(k) Distributions?

In addition to the restrictions on a 401(k), minimum distributions (RMDs) are also required. The required beginning date for taking the minimum withdrawals is April 1 of the first year after the later of the following:

• The calendar year when you reach age 73
• The calendar year when you retire

After taking the first required distribution, you must take distributions each year. If you don’t take a required minimum distribution, the IRS can assess a penalty of 25% of the amount not taken.

A 401(k) distribution may also be required when you leave the business that offered the employer-sponsored plan. Unlike previous generations of workers, you are more likely to change employers several times during your career. You should make sure that you do not forego any retirement savings in the process of changing jobs.

You can request a rollover of any 401(k) money into an eligible tax-deferred retirement account, such as an individual retirement account (IRA). If you rollover any funds into eligible retirement accounts, you will not have to worry about either the 10% penalty tax or income tax at the time of the rollover.

Can You Take a 401(k) Loan From Your Account?

Some 401(k) plans have specific provisions that allow plan holders to take loans out against the money in the plan. A 401(k) loan is not taxable if it meets the IRS loan criteria.

The IRS allows plan holders to borrow up to 50% of the vested account balance up to a maximum $50,000 loan amount. However, the loan must be repaid within five years, with equal periodic payments. You can have more time if you use the loan to buy a house that is your primary residence. This still requires substantial repayments over the life of the loan. Failing to repay on time could mean a tax assessment against the borrowed amount.

What Are the Penalties for Early Withdrawals?

A 401(k) is a retirement savings plan. The IRS allows for early withdrawals in certain circumstances. However, you must be aware of the potential penalties and withdrawal rules.

There is a 10% tax penalty for early withdrawals from your 401(k) retirement funds. For example, if you withdraw $10,000 early, the IRS levies a penalty of $1,000 on that amount. However, you also have to pay taxes on that $10,000 distribution amount as ordinary taxable income. The additional taxes will depend on your tax bracket and if you also have to pay state income tax.

How Can You Avoid Early Withdrawal Penalties?

Many retirement plans have early withdrawal penalties, including 401(k) plans, Roth IRAs, and traditional IRA withdrawals. However, there are certain situations that allow for penalty-free withdrawals, even before you reach the age of retirement.

Generally, you can cash out without penalty if you leave your job or have a financial hardship. You can also avoid early distribution penalties if you roll over a 401(k) to an IRA or other qualifying retirement accounts. You have 60 days to make a rollover without penalty.

This page provides an overview of 401(k) withdrawals. A lawyer can help you find specific answers to your legal questions about 401(k) accounts. An experienced attorney can explain your legal options and help you decide the best choice for your situation. Contact an experienced attorney for legal advice.