Early 401(k) Withdrawal Can Prove To Be Costly! Let’s See How?
With an uncertain economy and debt building up frequently, many people start looking forward for the money in their 401k plans. Although, it’s totally possible to withdraw your retirement money without having to return it, but there are terms and conditions depending on the individual’s personal situation and specific plan.
Here’s a quick round-up on the rules and regulations which you must keep a note of and be careful about before taking out any money from your 401(k).
# Eligibility Criteria
You are qualified for an early 401(k) withdrawal if your heavy financial need comes under the definition provided by the IRS. Typically, the qualifying needs include
- You, your spouse or dependents’ medical expenses
- Purchase cost of a house excluding mortgage payments
- Tuition and educational fees for you, your spouse or dependents
- Funeral expenses
- House damage repair costs
# Basic Taxes & Penalties
Regardless of why you need the money or what your age is, an early distribution of 401(k) attracts both income taxes (unless it’s a Roth IRA) and an additional 10 percent of the penalty. Let’s take an example. Suppose you wish to withdraw $20,000 from your 401(k) and you fall under 25 percent tax bracket, then the income taxes on your distribution could be $5,000 and an additional 10 percent penalty of $2,000 will be added. Thus, you end up having a deduction of $7,000, or 35 percent, from your required $20,000 distribution. This not only affects the withdrawal amount but also put a drastic effect on the remaining amount as you lose the opportunity to make savings for your future.
Related — FAQs On Late Payment & Late Tax Filing Penalties
# Penalty-Free Exemptions
There are several exemptions to the law that include
- An early retirement or leaving or losing job before the retirement age. In this case 401(k) distribution can be availed in a lump sum form. The same can also be scheduled as equal payments for lifetime, minimum 5 years or until reaching the age of 59 years and a half-years (whichever is longer). Though, both the cases are penalty-free, you will still have to pay the income taxes.
- In case of a disability where the medical expenses are required to be paid exceeding 7.5% of the adjusted gross income.
- In case of death, the payment is made to the beneficiary or the estate. The penalty is also waived off if the payments go to a former spouse incase the individual was mandated to give away the distribution under a qualified domestic relations order.
401k Loan Can Be An Inexpensive Alternative
As early 401(k) withdrawals can drastically affect your pocket, thus taking a 401(k) loan is a better option, of course if your retirement plan allows it. There are no penalties or taxes associated with the loan but you need to pay the interest, which will eventually be added to your own account. Repayment schedules are extremely strict and failure in complying with them can trigger heavy penalties. Also in the case of losing the job, the entire repayment is required to be done in the period of 60 days, otherwise face penalties.
The Verdict
Before opting for an early 401(k) withdrawal, it is advised that all the aspects must be carefully analyzed. In confusion, don’t hesitate in taking help from a professional tax expert so that you don’t miss a loophole and fall prey of heavy penalties. Don’t simply sacrifice your future savings just to fulfill the upfront requirements. Do take your decisions wisely.
