401k Withdrawal Options and Rules
A 401k plan is one of the best options for saving for your retirement. You are able to save pre-tax dollars into an account with investing opportunities. Many times the employer will match your contribution giving you, in essence, free money for you to invest as well. But in these economic times many people want to remove their 401k savings to pay bills and debt. Is this a good idea?
If you choose a 401k withdrawal and are not over the age of 59 1/2 you are going to be taxed heavily. The company will take tax as ordinary income from your 401k and give to the IRS for your portion of taxes due on the amount. A 10% penalty will also be assessed, which is not immediately taken out of your proceeds like a tax, but it due to the IRS nonetheless. You will be giving up a lot of retirement money back to the IRS. An 401k early withdrawal should be the very last resort if you are in need of money.
The IRS has essentially fives reasons that they deem valid for qualifying for a 401k early withdrawal. They are:
- Large medical bills for you or your family.
- Home foreclosure prevention or eviction from your principle residence.
- Cost related to purchasing a primary residence.
- Expenses for burial of parents, your spouse, children or any other dependent.
- Post secondary education costs for you, your spouse or children.
Even for a a hardship withdrawal you may still be taxed and penalized for the money you need. Most 401k plans will not allow for withdrawal unless all means of obtaining financing through other means or loans has been exhausted. And there are limits to how much you will be able to withdraw under the law.
In case you leave your current employer and they give you a lump sum distribution, you should do a roll over of the funds into a qualifying account like an IRA to avoid penalties and taxes. That would be a good time to learn beginner stock market investing. The IRS clearly insists that the intent of the 401k plan was for it to be used for retirement, or at least when you reach the age of 59 1/2.