What You Need to Know about 401k Withdrawals

By: LawInfo
401k plans are common retirement investment tools for United States workers. The plans, named for the section of the IRS code that defines them, allow workers to save for retirement and to defer income taxes until the time the money is withdrawn. However, with these tax benefits come restrictions on when money can be withdrawn from the plan without financial penalties.
401k withdrawals
Typically, specific criteria must be met before a person can withdraw funds from a 401k retirement plan. Usually no financial penalties will be incurred if an employee withdraws from a 401k plan and is 59 ½ years old or older, the plan holder dies or becomes permanently disabled, the plan terminates and no successor plan is identified by the employer or the plan holder has a financial hardship that qualifies for an exception to the general rule. 401k plan holders must take care to make sure that what they consider to be a financial hardship will be defined as a financial hardship by the IRS. Otherwise, if a 401k plan holder fails to meet any of the withdrawal criteria described above, then he or she is likely subject to a 10 percent penalty tax for an unqualified 401k withdrawal in addition to the ordinary income tax that is always assessed on 401k distributions.
Required 401k distributions
While many people are concerned about how soon they can take money out of a 401k plan, it is also important to be aware that there are certain circumstances which mandate a 401k distribution. Most plans require that a retired person or a working person who owns more than 5% of the employer maintaining the plan begin to make withdrawals by April 1 of the calendar year in which they turn age 71 ½. If neither of those criteria is met then this required distribution age is put off until April 1 of the calendar year in which the employee retires from the service of that employer.
A 401k distribution may also be required when an employee stops working for an employer. Unlike previous generations of workers, today’s employees often change employers several times during their careers. Employees should make sure that they do not forego any retirement savings in the process of changing jobs and should request that any 401k money be rolled over into an eligible retirement account. Funds that are properly rolled over into eligible retirement accounts will not be subject to either the 10 percent penalty tax for early withdrawals or income tax at the time of the rollover.
401k Loans
Some 401k plans have specific provisions that allow plan holders to take loans out against their 401k investments. If your 401k plan permits loans then the IRS will allow plan holders to borrow up to 50% of the vested account balance up to a maximum of $50,000. Borrowers should be aware that the loan must be repaid within 5 years, unless it is used to buy a primary residence and that substantially level repayments must be made over the life of the loan. Failure to adhere to these rules could result in a tax assessment against the borrowed amount.
401k plans are designed to be retirement savings plans. While the IRS allows for early withdrawals in certain circumstances, plan holders must be aware of the potential penalties for unauthorized early withdrawals in order to protect themselves from unwarranted tax penalties.
 
 

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