Employers have strict restrictions on the withdrawal criteria of 401(k) type accounts. Early 401k withdrawals before the age of 59.5 attract a penalty of 10% in addition to income taxes. 401k withdrawals can only be made on medical grounds or in cases of defined financial difficulty 401k hardship withdrawals are given on rare occasions and in some organizations, but it is mostly not possible.
For withdrawals, an employee has to resign from the employer (but still needs to pay the penalty and taxes). Non taxable withdrawals are only made in the case of exceptions such as death of the employee, separation of the employee from services after the age of 55, substantially equal periodic payments [section 72(t)] and medical expenses.
Take Advantage of the 401k Rollover
The best solution to withdrawing your 401k early is to first roll it over into an IRA. The first step to doing a 401k rollover is to open your account with a top IRA company.
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Getting a 401k Loan
Certain 401(k) type funds give the employee the option of taking a loan from it, provided it is repaid with after tax funds at a predefined interest rate. Controls are likely to be in place (the restrictive nature of which varies from employer to employer). The most common restrictions are on the amount that can be loaned as a percentage of the fund accumulated. The term of the loan also cannot exceed 5 years. The tenure of the loan can be more in the case of acquiring a first residence. Repayments have to be made in stipulated periods, monthly or quarterly. A default on the loan results in the amount loaned being treated as a withdrawal, liable for the usual penalty of 10% plus taxes.
Early Withdrawal from 401k
Usually rules to withdraw 401k early is subjective and varies across employers, so get in touch with your human resources department to get exact details. Whatever the differences, the underlying philosophy is the same. Withdrawal is only possible when you are going through hardships and comes with a 10% penalty. The 10% penalty should be sufficient reason to avoid an early withdrawal.
For instance, if you have $100,000 in your account, a withdrawal straightaway erodes $10,000, even before tax implications kick in.
Cons of Early Withdrawal
Even when faced with a situation where it makes ‘number sense’ to withdraw 401k early, first try to reduce investments or borrow from other investments you have. Then try reducing your retirement investments over the next few periods and pay off the loan. Only if even that doesn’t work, think about drawing down your 401(k) account. When faced with a situation where it doesn’t even make number sense to withdraw (such as you want to go on a world tour), taking out money from 401(k) is a must no-no.
Don’t take out your 401k money unless you are absolutely starving – take a loan when you can instead! You may promise yourself to replace funds once times are better, but that doesn’t usually happen – human nature!