A401(k) plan is a company retirement savings plan that offers tax benefits to both the employee and the company. Over time, the money accumulated in the account is allowed to grow tax-free. The goal is to defer cash withdrawals until retirement.
If you need to, you can withdraw money from the account before you reach the age of 59. With few exceptions, the account holder will face a large income tax bill as well as a 10% penalty.
And, because of the early withdrawal, their retirement savings will be permanently depleted.
You may want to consider other options before beginning an early 401(k) distribution. And if you have to make the withdrawal, there are ways to make it less painful financially.
How to withdraw money from your 401(k) sooner?
You will need to complete the necessary paperwork and provide the requested documents once you have determined your eligibility and the type of withdrawal you wish to make.
The paperwork and documents required vary depending on your employer and the reason for the withdrawal, but once you’ve completed everything, you’ll receive a check for the requested funds, hopefully without having to pay the 10% penalty.
Borrow from a 401(k)
In general, it is better to take out a 401(k) loan than to make an early withdrawal. Essentially, you lend each other money and agree to pay it back.
Instead of permanently losing part of your investment account, as you would with a withdrawal, a loan allows you to replace the funds, which you can do through payroll deductions.
You will need to see if your plan includes loans and if you qualify or you can also consider getting a personal loan from another source such as a bank.
If a 401(k) withdrawal is your only option, make sure your withdrawal qualifies as a hardship or exception with the IRS to avoid the 10% penalty.
Substantially Equal Periodic Payments (SEPP)
If the funds are in an Individual Retirement Account (IRA) rather than a company-sponsored 401(k), Substantially Equal Periodic Payments (SEPPs) are another option for withdrawing funds without paying the distribution penalty. anticipated.
If you are still working for your employer, SEPP withdrawals are not permitted under a qualified pension plan. If the funds are from an IRA, however, you can begin SEPP withdrawals at any time.
If you have a short-term financial need, SEPP withdrawals are not the best option. You must continue to make SEPP payments for at least five years or until you reach age 5912, whichever comes first. Otherwise, the 10% advance penalty remains in effect and you will have to pay interest on penalties carried over from previous tax years.
Taxpayers who die (for beneficiary withdrawals) or become permanently disabled are exempt from this rule.
The Internal Revenue Service (IRS) has approved three methods of calculating SEPP: fixed amortization, fixed annuity, or required minimum distribution (RMD). Choose the method that best suits your financial needs. Each method will calculate different withdrawal amounts.
Is it possible to withdraw money earlier from a 401(k)?
Yes, if your boss/employer allows it. There are, however, financial ramifications to this. Except in the following circumstances, you will owe a 10% penalty tax on the amount you withdraw:
- Whether it is considered a hard withdrawal under IRS rules
- Whether considered an exception to penalty under IRS rules
- If you need it for COVID-19 costs
Either way, the person making the early withdrawal will have to pay regular income tax on the money withdrawn for the year. The entire balance of a traditional IRA is taxable. Any money withdrawn early from a Roth IRA that has not already been taxed will be taxed. (Taxes should be paid on the profits of the account, not on the money you put into it, which has already been taxed.)
If the money does not fall under one of these exceptions, the taxpayer will be charged an additional 10% penalty on the amount withdrawn.