The typical American with a retirement plan has nearly $500,000 saved, with a large portion of that balance held in employer sponsored 401(k) accounts. These accounts are intended to help you save enough to replace your income when you are no longer working. However, there are circumstances that allow you to access the funds during your career.
You could be eligible for a withdrawal after a change in employment, a major shift in your financial position, or reaching an important age milestone. By understanding the situations in which you can access your 401(k), you can plan your retirement date and address financial needs during your working years.
You Can Access 401(k) Funds After Age 59 ½
The most obvious reason that you are permitted to withdraw from a 401(k) is reaching retirement age. This age can vary between retirement accounts, but for 401(k)s it is 59 ½.
You can begin to take withdrawals from your 401(k) at that age – even if you are still employed. You can use the funds you distribute for any reason and don’t need to justify your withdrawals to your employer, plan sponsor, or the IRS.
If you have a Traditional 401(k), you likely received a tax deduction when you contributed to the plan, so you’ll owe income tax on your distributions. On the other hand, if you have a Roth 401(k), you will not owe income tax when you withdraw funds over age 59 ½ if you meet the other criteria for a qualified distribution.
You Can Withdraw or Rollover Funds After Leaving Your Job
Prior to reaching retirement age, you are also able to withdraw from a 401(k) account if you leave the job which provided the plan. If you choose to, you will likely owe tax on Traditional 401(k) funds and a 10% early withdrawal penalty on both Traditional and Roth assets. However, there are certain circumstances in which you can avoid the penalty.
Avoid A 10% Penalty With An Age 55 Separation from Service Exception
If you are over the age of 55 when you leave your job, you can withdraw funds without a 10% penalty. If you have Traditional 401(k) assets, you will likely still owe tax on your distribution. On the other hand, if you have Roth 401(k) assets, you can avoid both tax and penalties on those distributions, assuming you meet the criteria for a qualified distribution.
Avoid A 10% Penalty with a Series of Substantially Equal Periodic Payments
Another option to avoid the 10% early withdrawal penalty is a series of substantially equal periodic payments – known as SoSEPP. This is a plan that you enact after leaving your job that allows you to take regular distributions from the account. The amount you can withdraw is determined based on life expectancy for you or you and your designated beneficiary.
Avoid Tax and Penalties with A 401(k) Rollover
If you want to leave your funds earmarked for retirement and preserve their tax-advantaged status after leaving a job, you can complete a rollover to an Individual Retirement Account [IRA]. An IRA provides a few key benefits over a 401(k) in certain cases.
First, an IRA is not limited to the investments that your employer chose to make available inside their plan. Second, IRAs provide enhanced access to your funds since you can make withdrawals for any reason at any time – though you are still subject to a 10% early withdrawal penalty for distributions before age 59 ½. Finally, IRAs can be managed by a financial advisor, while some 401(k) plans do not have this option.
Withdraw After Experiencing a Financial Hardship
If you are still working for the employer who provided your plan and are under age 59 ½, you can consider a hardship withdrawal to access your funds. To qualify for this type of withdrawal, you must have an immediate and substantial financial need.
Some of the most common hardships that can qualify for a withdrawal are:
- Medical care for yourself, your spouse, your dependents, or your beneficiary
- Costs associated with buying a home
- Tuition and expenses for higher education
- Payments needed to avoid eviction or foreclosure
- Funeral expenses for your spouse, child, dependent, or beneficiary
- Certain repair costs for your home
When you take a hardship withdrawal, you are generally still subject to applicable taxes and an early withdrawal penalty. However, there are certain circumstances which exclude you from the 10% early withdrawal penalty. The most common exceptions are qualified higher education expenses, buying your first home, and medical expenses exceeding 7.5% of your Adjusted Gross Income [AGI].
In general, you cannot pay back the money you take from a hardship withdrawal. If you want to repay the amount to keep yourself on track for a successful retirement, you should consider a loan from your 401(k) instead.
A 401(k) Loan May Be Available
Loans are a feature of some 401(k) plans, though not all plans are required to offer them. If your plan offers loans, the maximum amount you can borrow is 50% of your vested balance or $50,000 – whichever is less.
The repayment period for a 401(k) loan is generally 5 years or less and requires at least quarterly payments. However, there is an exception that allows you to spread the repayment over a longer period if you are using the loan to purchase a home.
Before you apply for a 401(k) loan, consider that you may need your spouse’s approval to borrow more than $5,000 from your plan. You should also keep in mind that your employer may require you to repay the entire balance of the loan if you leave your job.
In general, it is wise to leave your 401(k) untouched to take advantage of compound returns that can help grow your nest egg. However, emergencies happen, and you have options to access these funds if they are needed. An experienced financial advisor can help you prepare for financial emergencies and weigh your options for responding to them.
Solidify Your Retirement Plan with DreamWork
At DreamWork Financial Group, we can help you determine when to take a distribution from your 401(k) during retirement or after leaving your job. Our experienced advisors can also help you weigh the options to pay for unexpected expenses through a hardship withdrawal or loan.
We help you manage your entire retirement plan – from starting to save to stretching your income over your lifetime. Our financial planning process is centered around our innovative wealth management program called Investing Gameplan™ which helps guide you through every phase of life.
To learn more about Investing Gameplan™ or discuss your personal financial situation, contact us today.