401(k) withdrawal rules can be fairy complex. Many factors come into play when determining if you can, or should, withdraw from your 401(k) plan. In this blog, we will answer many of the frequently asked questions we hear about 401(k) withdrawals.
What are the 401(k) withdrawal rules?
Typically, 401(k) accounts are for retirement, and withdrawals prior to age 59.5 are taxed and include a 10% early withdrawal penalty. But, as with all tax rules, there are exceptions. The IRS has specific withdrawal rules for all retirement accounts, which are important to consider. In addition, each 401(k) plan has what’s called a “Summary Plan Description,” which lays out that specific plan and the rules associated with withdrawals from it. You are more limited on options if you are trying to withdraw from a 401(k) while still employed by a company.
How can I withdraw money from my 401(k) without penalty?
The main way to avoid a penalty is to wait until you are 59.5-years-old before withdrawing from your 401(k) account.
There are a few reasons you can withdraw money from a 401(k) prior to 59.5 without incurring a penalty. These include disability, death, and Equal Payments (IRS code 72t).
A few other less common exceptions to the 10% early withdrawal penalty is in the event of a Qualified Domestic Relations Order (simply put, a divorce decree awards an ex-spouse a portion of your 401(k)) and unreimbursed medical expenses that exceed 10% of your AGI.
Can I just withdraw money from my 401(k)?
This depends. If you are still working for the employer, it is likely the employer has rules on the plan for withdrawals. Some employers do not allow in-service withdrawals at all.
Some employers allow hardship distributions from the account. These withdrawals, unless made from a Roth 401(k), are generally taxed and incur a 10% early withdrawal penalty. They are limited to the amount necessary to cover the immediate and heavy financial needs. It is up to the employer to determine if the employee qualifies for this withdrawal.
If you are not still working for the employer, you generally can withdraw money from your 401(k) plan, but not without penalty if the withdrawal is not used for any of the IRS 401(k) qualified exceptions discussed above.
How long does it take to get money from 401(k) withdrawal?
This depends on the plan and the employer rules with the plan. This can take anywhere from days to weeks depending on the plan. You will need to ask your employer and the plan administrator to find out the timeline for 401(k) withdrawals.
What is the cost if I withdraw my 401(k) early?
The typical early withdrawal penalty is 10%. This 10% is on top of income taxes you pay on the withdrawal. This can be a costly decision, so ensure you have exhausted all other options before deciding to take money from a 401(k) early.
At what age is 401(k) withdrawal tax-free?
Age 59.5 OR the year in which the employee is age 55, if separated from service.
Do I pay taxes on 401(k) withdrawal after age 60?
Unless it is a Roth 401(k) account, you will pay income taxes on withdrawals from a 401(k) regardless of age. This is because while adding to this account, taxes were not paid. You added to it on a tax-deferred basis. Taxes are only deferred for as long as the money remains in the account. If you are age 60 or older, you will not have to pay the early withdrawal penalty when you withdraw money from a 401(k).
Do I pay state taxes on 401(k) withdrawals?
401(k) withdrawals are considered income. If you live in a state with income tax, you will have to pay state income tax on the 401(k) withdrawal.
How do I report a 401(k) withdrawal on my tax return?
You should receive a form 1099-R from the 401(k) administrator. This form will show how much you withdrew and how much they withheld in taxes from the withdrawal (typically 20%). You will enter this on your tax return software similar to how you enter income from a W-2.
Why would a 401(k) withdrawal be denied?
Some employer plans do not allow for in-service withdrawals. If you are still working for the employer, you may not be able to simply withdraw funds. You could check to see if your employer allows loans from the plan.
How much should I have in my 401(k) at 55?
This depends on many factors including when you want to retire, how much money you need to live off of in retirement, and how you decide to invest your retirement funds. It is best to check with your financial planner to make sure you are on track for retirement.
How do I avoid paying 20% tax on a 401(k) withdrawal?
The IRS typically requires the administrator to withhold 20% of a 401(k) withdrawal to pay taxes. You may owe more than that come tax season, but this is the amount the administrator must withhold per IRS rules.
To avoid having to pay this when you file taxes (i.e. if you want to get this 20% back at tax time), you need to have rolled your distribution (plus 20% to cover the taxes withheld) into another retirement plan, like an IRA, within 60 days of the distribution. If you do not do this, the withdrawal is treated as an early withdrawal and may also incur an additional 10% penalty.
How many times a year can you pull from your 401(k)?
There is no IRS limit to the amount of times you can withdraw money from a 401(k) once you reach age 59.5.
Each plan has its own rules, and you will need to speak with the plan administrator to find out if there is a limit to how many withdrawals you can make in a year.
Can a company keep you from withdrawing your 401(k)?
If you are still employed with the company, the plan can deny you in-service withdrawals. Each plan has its own rules and regulations, and some are more strict than others on in-service withdrawals. Some do not allow them at all. Some allow loans from 401(k)s while others do not. Some plans also allow for hardship withdrawals and some do not. There is no rule that forces a company to give you access to your 401(k) while still employed.
Do you need a reason to withdraw from 401(k)?
This depends on the plan. Some plans allow hardship withdrawals only, and no other type. Some only allow loans. And some allow nothing. It is important to talk to your plan administrator to find out what the rules of your plan are.
Should I take Social Security or withdraw from 401(k)?
If you are nearing, or are in retirement, this may be a question you have been asking yourself. There is no black-and-white answer to this because as with most things finance, it depends. It is important to know the pros and cons of taking Social Security early vs. tapping into your 401(k) to wait for the Full Retirement Age for Social Security.
Many factors should be taken into consideration when making this decision, including, but not limited to: age, tax brackets, 401(k) balance, life expectancy, etc. If you are wondering how to effectively draw on retirement so you don’t run out of money later in life, hiring a financial planner could be the best investment in yourself you could make.
Making a 401(k) withdrawal
If you are thinking of making a 401(k) withdrawal it’s important to know all of the rules associated with it. Once you understand all of the rules, then you can make an informed decision about when a 401(k) withdrawal may be right for you. If you are interested in having a comprehensive financial plan, schedule a free discovery call with one of our financial advisors today.
Kayla Welte, AFC®, ChFC®, CFP®, has been helping clients maximize their finances since 2009. With a background in financial education & counseling, Kayla is passionate about helping people prioritize & reach their financial goals. Kayla is a Financial Planner at District Capital Management, a financial planning firm designed to help professionals in their 30s & 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, & maximizing their money. Schedule a free discovery call today.