The 4o1k plan can be choppy waters to navigate. I myself have had plenty of questions about my 401k plan . So over the years I have done a lot of research. As a result I have put together the following guide to help answer some of your questions.
I have found that the number one question people ask is When can I cash out my 401k?
You can cash out your 401k at any time but if you do so before age 59 1/2 you will pay a 10% penalty on top of all applicable taxes you owe. If you wait until after age 59 1/2 you will avoid the 10% early withdrawal penalty but you are still obligated to pay all relevant taxes.
What is a 401k plan?
The 401k is a government approved, employer sponsored retirement savings plan. The 401k allows employees to save and invest a portion of their paycheck before taxes are taken out. Taxes are paid when the money is withdrawn from the account. The employer will hire an administrator to oversee the accounts of its employees. Often the Employer will offer a match to your contributions. Something like 50 cents on the dollar up to $500. Some employers offer a percentage of your salary as a match.
Can I cash out my 401k right now?
You can cash out the vested portion of your 401k any time you like as long as you are willing to accept the consequences of doing so. The consequences being payment of a 10% penalty fee as well as federal income tax and any applicable state taxes on the amount you withdraw.
If you absolutely must access the funds in your 401k plan, a loan might be a better option.
Can I take a loan against my 401k?
The IRS allows you to borrow against your 401k, provided your employer permits it. Although the IRS ALLOWS for you to borrow, your employer is not REQUIRED to allow it. If your employer plan does allow for loans, the employer will set the terms of the loans.
The maximum loan permitted by the IRS is $50,000 or half of your vested account balance, whichever is less. During the loan you pay principle and interest to yourself directly from your paycheck, after-taxed. Generally, the maximum term is five years, but if you use the loan as a down-payment on a principal residence, it can be as long as 15 years.
What happens to my loan if I quit or retire early?
If you still have a loan balance when your end your employment and fail to pay the balance, the government will treat the unpaid balance as an early withdrawal and you will be subject to the 10% early withdrawal fee as well as all applicable income taxes.
In order to avoid these costly fees and taxes you will need to capitalize on one of several options. You can simply pay back the loan in full within 60 days of the end of your employment. Another option, if your new employer offers it, is to roll your old 401k, loan included, into your new employers plan.
Finally, you can apply for a 6 month extension using IRS form 4868. This will not eliminate the need to pay taxes and fees but it can buy you some time to decide how you will proceed.
What happens to my 401k if I quit my job or retire early
When you quit your job or retire, you are entitled to 100% of the vested balance of your 401k account. However, if this event occurs before you reach age 59 1/2 you will need to decide what you are going to do with the money.
Since the 401k plan is a tax sheltered account administered by your employer, when you leave your employer, the tax shelter goes away. Not only that but you will be subject to a 10% early withdrawal fee.
You do have the option to avoid this by rolling the money over into a new tax sheltered account. If you start a new job that also offeres a 401k plan you may be able to roll over your old account into the new one and avoid any taxes or fees.
You will have 60 days from the date you receive payment to complete the rollover and avoid penalty so you will want to be sure to figure out the details of your rollover quickly.
In a direct rollover, the funds are sent straight from your 401k into an IRA without you touching the funds. It is important that you specify a direct rollover so that you don’t have the check made payable to you — triggering a mandatory 20 percent withholding for taxes.
In order to avoid costly errors, be sure to check with the IRS rules on rollovers for any changes or updates before proceeding.
You may also wish to hire a financial professional to help with this event.
Can I take a hardship withdrawl?
A hardship withdrawal is a 401k distribution made due to an immediate financial need. The amount must be necessary to satisfy the financial need. Although the IRS allows for employers to offer penalty free hardship withdrawals, they do not require them to offer it.
Here are the typical reasons one might apply for a hardship withdrawal.
- You are disabled
- Your medical debt exceeds 7.5 percent of your adjusted gross income
- You are required by court order to give the money to your divorced spouse, a child, or a dependent
It is also important to note that if you take a hardship withdrawal, you will not be eligible to contribute to your 401k for six-months after the hardship disbursement. Your 401k plan administrator may also require supporting documentation or proof of hardship. Be sure to check with your administrator before making the final decision on hardship withdrawals.
What can I do when I reach age 59 1/2
At age 59 1/2 you are allowed to begin taking penalty free withdrawals from your 401k. You are still obligated to pay federal income tax as well as any applicable state taxes.
What is a Required Minimum Distribution?
When you reach age 70 1/2, if you are not already, you MUST begin taking the required minimum distribution. Taken directly from the IRS website….
“Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. “
Basically, money can not stay in your retirement plan forever. What the required minimum distribution rule means is that if you are over the age of 70 1/2, and were not planning on taking distributions, too bad. You must take the full required minimum distribution by December 31 each year. Failure to do so will result in a 50% excise tax on the difference between the required distribution and the actual distribution.
For more information, check out the IRS frequently asked questions on required minimum distributions