Withdraw from Your 401K

A 401(k) is a type of retirement savings option offered to many workers through their employers in the United States. Employees with 401(k) plans are able to deposit a percentage of their paycheck into an account before the money is taxed, and many employers agree to match a portion of the employee's contributions (sometimes up to 100%). Withdrawing from a 401(k) is not typically allowed until the account holder reaches 59.5 years of age, though some circumstances allow funds to be accessed earlier.

Steps

Withdrawing After Age 59.5

1. Understand 401(k) withdrawal after age 59.5. At the age of 59.5, you are to considered to have reached the minimum distribution age, and can therefore begin withdrawal from your 401(k) without being subject to a 10% penalty on early distributions. Withdrawals will be taxed at your current income rate, due to the fact that your contributions were tax-deferred.
   • Tax deferral is when a taxpayer delays payment of taxes to a future period. In theory, net taxes paid should be the same. However, taxes paid after retirement are typically at a lower rate than when working, thus, the tax savings. Taxes can sometimes be deferred indefinitely.
   • There are multiple options for withdrawal available once you reach 59.5, and what option you choose will depend on your goals and overall financial situation. Before electing an option, it is always wise to sit down with an adviser.
   • Most companies offering 401(k) plans have knowledgeable advisers who understand the complexity of 401(k) plans, the choices available to plan participants, and the consequences of each choice.
   • Alternatively, you can seek outside help from an accountant or financial planner to further your understanding and provide more diverse options.
2. Consult a financial adviser to answer any questions. Consulting a financial adviser from the 401(k) account is a critical step. The intricacies of your retirement account will usually be quite complicated and difficult to negotiate yourself, and therefore expert guidance is often required.
3. Contact your plan administrator to set up a lump sum distribution withdrawal, purchase an annuity, or rollover your 401(k). Any withdrawal activity will begin with a discussion with your plan administrator. While your employer sponsors the plan, the plan is usually managed by a third-party financial institution, and the plan administrator serves as a connection between you and your plan.
   • If you know who they are, contact them to discuss options for creating a lump sum distribution withdrawal, purchasing an annuity, or rolling over your 401 (k), and they can guide you as to next steps.
   • Ask your employer who your plan administrator is if you are unsure.
4. Consider setting up a lump-sum distribution. The lump sum distribution is typical form of payout for a 401(k). It refers to a payout you can take as taxable income. Plans generally offer a variety of distribution amounts at the option of the account holder, including taking the entire sum at once. Options often include a periodic dollar amount, or a fixed percentage of the account on a regular basis.
   • Note that total withdrawal and payment of taxes rarely makes financial sense for most people unless your tax bracket or lump sum is low.
   • For example, you might choose to take $2,000 monthly, $10,000 quarterly, or 1% of the account balance each quarter. Typically, most plans allow you to select a particular amount to receive every couple weeks, months, or quarters. You're also allowed to tweak the plan periodically throughout the year.
   • Be sure to communicate with an adviser before opting for a particular distribution amount and schedule.
   • For specific situations, such as separation from employer or separation from employer with an outstanding loan, click here for recommended cash distributions.
5. Buy a Variable Annuity to Supplement Your Retirement Income. Buying annuities is a means of receiving an income for the rest of your life, without having to worry about how the source of the income is invested. You can also assign these accounts to your spouse in the event of your death.
   • Annuities allow you to essentially exchange your 401(k) for a guaranteed income for life, which can be effective for individuals who are worried about exhausting their savings. It can also be useful for individuals who are looking to avoid the hassles and worry of investing.
   • Be aware there are risks associated with this option, including what can be fairly significant fees. Be sure to consult an adviser before proceeding, as they can inform you as to what your various options are and how to proceed.
6. Consider rolling money into a traditional IRA. An IRA is an account at a financial institution that allows you to save for retirement with tax-free growth or on a tax-deferred basis. A rollover into an IRA refers to the process of moving assets from your 401(k) into a traditional IRA, where you make fiscal contributions that you deducted on your tax return and where any earnings can potentially grow tax-deferred until you withdraw them in retirement. This option can allow greater flexibility and control over investments, and is recommended by many advisers. Within an IRA, you are free to invest money as you see fit.
   • To rollover money into an IRA, simply contact the the company that holds your 401(k) plan or your plan administrator, and ask for the money to rolled over into an IRA of your choosing. They will guide you through the process. Typically you will need to setup an IRA beforehand, and you can do so through most financial institutions. The major providers of IRA's are current Vanguard, Fidelity, and T.Rowe Price.
   • Many retirees find themselves in a lower tax bracket than they were in pre-retirement, so the tax-deferral means the money may be taxed at a lower rate. An IRA also allows you greater access to a wider range of investment.
   • Rollovers can be direct - moving from one plan to the other - or indirect when the 401(k) plan administrators sends you the funds directly. If that occurs, you have a single 60 day period to open the new IRA account and avoid income tax; otherwise, income tax on the entire distributed amount will be due.
   • Since investment in traditional IRA's is tax-deductible (and therefore pre-tax income is contributed), if your 401(k) contributions are also pre-tax, the rollover is fairly simple. Upon withdrawal from the IRA, however, taxes will be owed on the withdrawn sums.
   • Money in a 401(k) cannot be touched in the event of personal bankruptcy or lawsuits, meaning that it's protected from your creditors. Unfortunately, this is not true of IRAs, which are more vulnerable: $1 million is exempted and may be more at discretion of bankruptcy court.
   • If you have more than one retirement account, it's sometimes recommended that you consolidate into an IRA, which is easier to manage and gives you chances to qualify for discounts in mutual funds.
7. Consider rolling money into a Roth IRA. With a Roth IRA, you make contributions with money you’ve already paid taxes on (after-tax) and your money may potentially grow tax-free, with tax-free withdrawals in retirement. This option can also give you a wider range of potential investment opportunities than a 401(k). Talk to your financial advisor if you are unsure whether to use a Roth IRA.
   • First, verify that your current 401(k) plan allows for rollovers to Roth IRA’s. Choose a Roth IRA plan that works best for you and open an account.
   • Note that 401(k) transfers of tax-deferred money will trigger tax if Rolled into Roth IRA. Seek tax help.
   • Get required forms from new and old providers. If possible, choose “direct rollover” as an option, so that money goes from 1 account to another without your manual involvement.
   • Deposit checks immediately to avoid delays and confusions.
   • See more detailed instructions here.
8. Consider doing nothing. Doing nothing with your 401(k) once you reach 59.5 years of age is also a viable option. Providing you are not retiring and are continuing to work, you can continue investing pre-tax funds into your 401(k) and allowing the principle to grow tax-free, just as you did up until that point.
   • You are not required to take minimum distributions from a 401(k) until you are 70.5 years old.
   • If you are planning continuing contributions to your 401(k) for a period after 59.5, it is wise to consult with your adviser at work to discuss options for re-configuring your investments as to reduce risk and preserve capital as move closer to retirement.

Withdrawing Before Age 59.5

1. Understand the consequences of withdrawal. Your 401(k) is meant to provide retirement income and should be considered a last-resort source of cash for expenses before then. Withdrawing from your 401(k) before you reach retirement age can come with some IRS consequences.
   • If you withdraw any amount from your 401(k) before age 59.5, you will usually pay a 10% penalty to the IRS on top of ordinary taxes for the amount you're withdrawing. There are hardship exceptions from penalties; for example, if you have a disability or excessive medical bills.
   • On withdrawals after 59.5 years age, there will be no penalty, but the amount you withdraw will be considered taxable income for that year, so you'll owe taxes at the end of the year.
   • Generally, after age 70.5 and if you are retired, you must begin withdrawing from your 401(k) or IRA accounts according to the conditions of the agreement.
   • The costs of early withdrawal are not only limited to the 10% penalty and ordinary taxes. You are also interrupting the wealth compounding effect of time and regular contributions. Withdrawing even a year or two early can result in thousands of potentially lost retirement funding.
2. Consider alternatives if you need emergency withdrawals. Since withdrawing ahead of time is expensive, it is wise to consider alternative options first if funding is necessary.
   • Borrowing funds from your 401(k) plan allows access to funds without technically withdrawing. Your plan must offer a loan option for this to be possible. While borrowing funds will interrupt the long-term compounding, borrowing and repaying the loan is a better option than taking a distribution and paying the penalty and taxes due. However, note that failure to repay the loan will trigger a distribution that will be subject to penalty and taxes
   • Loans must be repaid within 5 years and are subject to a competitive rate (prime + 1%). Many people fail to make contributions during loan payback since deductions go to repayment. Contact your adviser to determine if this is the right approach for you and explain specific restrictions. For example, you cannot borrow funds and then roll them over into another account.
   • Low-interest loans from a lender would be a smarter withdrawal option than dipping into your 401(k). In the long run, taking money out of the 401(k) will yield you a net benefit of barely half a withdrawal.
   • Looking into sale of assets, loans from friends or family, reducing expenses, or utilizing any cash savings are often better options then subjecting yourself to penalties from early withdrawal.
3. Withdraw without penalty under IRS rule 72(t). This provision allows you to withdraw money based on your life expectancy. This simply means that the distribution you can receive under this plan is calculated using your estimated life expectancy (according to statistics tables), which helps to ensure that the distribution you receive will not lead to prematurely depleting your account.
   • Under this rule, you must make withdrawals for at least 5 years or until you reach age 59-1/2, whichever is longer.
   • This most commonly occurs when employees are 56 and about to retire, withdrawing a certain amount of money each year until 61. Or you could withdraw less for a longer period of time.
   • You can avoid the 10% early withdrawal penalty this way, but you'll still pay taxes on the money withdrawn, losing compounded earnings you'd otherwise have had.
4. Contact your plan administrator. If you plan to withdraw before the age of 59.5 using any of the above methods, your administrator can guide you through the process of bringing funds from your 401(k) to your bank account.

Making a Hardship Withdrawal

1. Determine if you meet the criteria for hardship withdrawal. In the event of an emergency, some plans allow participants to receive early distributions from a 401(k) plan without being subject to the standard 10% early withdrawal penalty (in some circumstances). This is known as a hardship withdrawal. It is important to note that taxes will still be due on any early distribution, and it is necessary to prove that the emergency situation is valid. Criteria for qualification include:
   • You or a member of your immediate family has exceptionally high medical expenses.
   • You are buying a principal home.
   • You are paying college tuition for yourself or family.
   • You need the money to stay out of foreclosure.
   • You need it for the cost of a funeral.
   • If there are necessary home improvements to be made on your principal home.
2. Determine if you qualify for penalty-free withdrawals. In some retirement packages, there are a limited number of specific criteria which allow you to take money out of your 401(k) without having to pay the 10% penalty. Note that if you do not meet these criteria and are not 59.5 or older, you will be required to pay the penalty. The criteria for exemption include:
   • Becoming totally disabled.
   • Are in debt for medical expenses that exceed 7.5% of your adjusted gross income.
   • Are court-ordered to give the money to a divorced spouse, a child, or a dependent.
   • Are fired in the year you turn 55, or later.
3. Prove you need the money due to a hardship. If you qualify for the above-described criteria, you need to provide your employer with financial proof of your hardship, this could include any financial documentation or bills that the employer requires to properly verify hardship. Absolute necessity is a key component of being eligible for this sort of withdrawal.
   • Note that there is an exception to needing to provide financial documentation. This is in the event that your employer uses a "self-certification" method of taking hardship withdrawals. Under this approach, if you fall under the above criteria, you are not required to provide any additional documentation. In cases of self-certification, you are prohibited from making new contributions to the 401(k) plan for six months, also foregoing any employer matching funds. Hardship distributions cannot be paid back and can dramatically affect the ending balance of the account at retirement. Contact your employer to inquire about this option.
   • Not every employer makes hardship withdrawal provisions in their retirement package, so it's important to check the specific requirements and regulations with your financial institution and your employer before you move forward.
   • Usually, you'll need to contact your plan administrator or your HR department at work to get these specific questions answered, or be directed to the proper channel.
4. Roll over the funds. Some employers allow non-hardship withdrawals in the form of fund rollovers. This takes money from your 401(k) and redistributes it to another account, such as an IRA, without a tax penalty. Once the money is rolled over, you might have fewer restrictions for withdrawing due to fewer administrative constraints.

Tips

• If you do not want to disclose your personal finances to your employer but need a hardship withdrawal, you can undergo a self-certification process. This option disallows you from contributing back to your 401(k) for 6 months, however.

Warnings

• Some companies do not allow you to withdraw from your 401(k) while you are still employed by them.
• Employers can choose to disallow hardship withdrawals. Make sure you examine your 401(k) documents (including the fine print) before choosing to withdraw.
• If you do not place rolled over funds into a new account within 60 days, you will receive a 10% penalty.
• There is a 10% penalty on hardship withdrawals if you are under 59.5. In addition to the 10%, whatever you take out is taxed as income. So, for example, if you take out $10,000 from your 401(k), you might actually receive only a little more than half of that sum.

Related Articles

• Write a Hardship Letter for Mortgage Loan Modification
• Use Your 401k to Start a Business
• Set up a Self Directed Real Estate IRA
• Start Building Wealth at a Young Age
• Open a Roth IRA Account
• Select an IRA
• Roll over Assets Into a Traditional IRA
• Withdraw from a SIMPLE IRA
• Manage Your 401K Investments
• Invest in 401K
• Calculate Taxes Owed on Hardship Withdrawals
• Apply for a Hardship Loan

Sources and Citations

See also

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• Know How Much to Give for a Retirement Gift
• Make a Retirement Scrapbook
• Use Life Insurance in Your Retirement Planning
• Transfer Retirement Funds to a Roth Ira
• Start a Retirement Home in Ontario
• Retire from a Job You Love
• Prepare for Early Retirement
• Prepare for Retirement in Your 20s
• Plan for Long Term Care

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