Can I Withdraw Funds from a 401k Before Retirement?
Exterior of the Internal Revenue Service office in midtown New York. (Photo credit: Wikipedia)
If you are investing in a 401k you are doing a very smart thing. If your not why not? Many people do not invest in a 401k because they feel someday they made need the money. A 401k is a great way to save because the growth of your money is tax free until to withdraw it. Then you pay the taxes and hopefully you are in retirement when your tax rate is much lower. Another benefit is many employers match your 410k deposits thus doubling you money.
There is a lot of confusion about withdrawals before retirement age. First off to not be subject to a penalty you have to wait till your 59 1/2. Then you just pay taxes on the growth. But if you need the money before then you pay the taxes plus a 10 percent penalty.
If you decide to go ahead and take a withdrawal before 59 1/2 you can only do so under a limited number of reasons, these are called hardship distributions, even if you are willing to take the 10% penalty. The IRS permits 401k withdrawals only in the case of disability, death, a severance from employment, if you turn 59 1/2 or incur a financial hardship, which includes medical expenses, tuition and buying a home. You can also take a distribution if your employer’s plan terminates without a successor plan in place. Beyond these options, you cannot take a straight distribution from the plan.
When you have a withdrawal at tax time you need to file form 5329.
You report the withdrawal on your taxes using the tax form 5329. If this form indicates that you owe the 10 percent penalty, transfer the amount of the penalty that you computed on Form 5329 to line 58 for Form 1040.
How to handle rollovers and loans.
Rollovers and loans are not considered distributions and are treated differently. They are not subject to taxation or a 10% penalty. If you take a loan you must pay it back. If you are fired or leave your job your 401k loan is payable in full.
In the long run it may be better to take a 401k loan. You will not have to pay any taxes or penalties.
Category: Investing, Retirement, Uncategorized
It is important to note that a 401k loan will hurt your retirement because you’ve taken out money that could be sitting there earning interest. You should only take money out from your 401k if it is a dire emergency.
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A 401k loan has to be done only in a worse case scenario. It’s kinda beneficial there is a penalty because it makes you think twice about taking it out. It’s a nice psychological and financial roadblock.