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401k Early Withdrawal Rules, Calculator
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Published: November 1, 2006
A 401K is your retirement income, meaning it is meant to be used after retirement. A 401K early withdrawal is not as easily handled as a plan loan, as the IRS only allows for it under certain circumstances. This means that there are several 401K early withdrawal rules, which can be very costly to you now and after retirement.
What options do I have for a 401K early withdrawal?
Also known as Hardship Withdrawals, there are two types of withdrawals that are permitted from 401K plans. Each has its own set of rules and neither are easy to get.
Financial Hardship Withdrawal
This withdrawal is allowed only if the money is needed to prevent foreclosure or eviction from your home, to buy a primary residence, to pay non-reimbursed medical expenses or to pay off college tuition that is due within the next twelve months for either yourself or a dependent. This type of withdrawal is subject to income taxes as well as a ten percent early withdrawal penalty if you happen to be under the age of 59 ½.
Penalty-free Withdrawal
Under the Internal Revenue Code section 72(t), you can receive a 401K early withdrawal where you pay applicable income taxes but no penalty. A penalty-free withdrawal can only be achieved if you become totally disabled, are required by a court order to pay money to a divorced spouse, child or other dependent or are in debt for medical expenses which exceed 7.5 percent of your adjusted gross income. You can also receive this withdrawal if you are separated from service in, or after the year you turn 55, due to permanent layoff, termination, quitting or taking early retirement. This also applies if you are separated from service with a set up payment schedule that allows you to withdraw money in substantially equal amounts over the course of your life. With this type of withdrawal payment schedule, you must continue for five years or until reaching the age of 59 ½, whichever is longer.
A 401K early withdrawal is meant for emergencies only and is not meant to be treated as lightly as a loan. After you have taken a 401K early withdrawal, you cannot repay it later on. Once that money is out, it's out, you cannot put it back. Some employers offer a plan loan, or a loan that can be taken from a 401K, and might even require it before taking a Hardship Withdrawal. Not only is this tax and penalty free, it also allows you to continue contributing into the 401K plan while paying off the loan. In the case of plan loans, it is important to understand that, should you leave the employer before repaying the loan, the balance must be repaid or else it is considered a withdrawal, which will then lead to taxes and penalties.
Consider using a 401K calculator before deciding to take a Hardship Withdrawal, as you can lose 35-45 percent of the money in taxes and penalties. The money withdrawn from your plan may seem like a lot, but a 45 percent loss can leave you with just a little over half. There should be a lot of planning involved before taking a 401K early withdrawal.
A 401K early withdrawal can hinder your retirement as well. A small amount taken out today can hurt a lot more in the end. While $10,000 might not seem like a whole lot at present, the lost average annual return for that money can add up to a lot by the time retirement arrives. Should you need a 401K early withdrawal, consider as many other options as possible first; it is meant as a last resort.
Linton, Clifton. Hardship Withdrawals Give Access to Savings, But at a Cost. 2002. mPower. 30 October 2006. http://www.401khelpcenter.com/mpower/feature_12190 2.html.
401k Withdrawal Options. 2006. Rolloveraid.com. 30 October 2006. http://www.rolloveraid.com/.
What options do I have for a 401K early withdrawal?
Also known as Hardship Withdrawals, there are two types of withdrawals that are permitted from 401K plans. Each has its own set of rules and neither are easy to get.
Financial Hardship Withdrawal
This withdrawal is allowed only if the money is needed to prevent foreclosure or eviction from your home, to buy a primary residence, to pay non-reimbursed medical expenses or to pay off college tuition that is due within the next twelve months for either yourself or a dependent. This type of withdrawal is subject to income taxes as well as a ten percent early withdrawal penalty if you happen to be under the age of 59 ½.
Penalty-free Withdrawal
Under the Internal Revenue Code section 72(t), you can receive a 401K early withdrawal where you pay applicable income taxes but no penalty. A penalty-free withdrawal can only be achieved if you become totally disabled, are required by a court order to pay money to a divorced spouse, child or other dependent or are in debt for medical expenses which exceed 7.5 percent of your adjusted gross income. You can also receive this withdrawal if you are separated from service in, or after the year you turn 55, due to permanent layoff, termination, quitting or taking early retirement. This also applies if you are separated from service with a set up payment schedule that allows you to withdraw money in substantially equal amounts over the course of your life. With this type of withdrawal payment schedule, you must continue for five years or until reaching the age of 59 ½, whichever is longer.
A 401K early withdrawal is meant for emergencies only and is not meant to be treated as lightly as a loan. After you have taken a 401K early withdrawal, you cannot repay it later on. Once that money is out, it's out, you cannot put it back. Some employers offer a plan loan, or a loan that can be taken from a 401K, and might even require it before taking a Hardship Withdrawal. Not only is this tax and penalty free, it also allows you to continue contributing into the 401K plan while paying off the loan. In the case of plan loans, it is important to understand that, should you leave the employer before repaying the loan, the balance must be repaid or else it is considered a withdrawal, which will then lead to taxes and penalties.
Consider using a 401K calculator before deciding to take a Hardship Withdrawal, as you can lose 35-45 percent of the money in taxes and penalties. The money withdrawn from your plan may seem like a lot, but a 45 percent loss can leave you with just a little over half. There should be a lot of planning involved before taking a 401K early withdrawal.
A 401K early withdrawal can hinder your retirement as well. A small amount taken out today can hurt a lot more in the end. While $10,000 might not seem like a whole lot at present, the lost average annual return for that money can add up to a lot by the time retirement arrives. Should you need a 401K early withdrawal, consider as many other options as possible first; it is meant as a last resort.
Linton, Clifton. Hardship Withdrawals Give Access to Savings, But at a Cost. 2002. mPower. 30 October 2006. http://www.401khelpcenter.com/mpower/feature_12190 2.html.
401k Withdrawal Options. 2006. Rolloveraid.com. 30 October 2006. http://www.rolloveraid.com/.
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