When it comes to 401(k) plans, most people are obsessed with filling theirs to the brim. Stashing more money away in a shorter time span is a great way to use a 401(k), but eventually you’re going to have to tap those funds. Like anything else to do with your retirement account, there are special rules about when and how you can access your 401(k) — let’s walk through the four most important types of withdrawals now.
Early Withdrawal. If you’re younger than 59½ years of age when you decide to tap your 401(k) for no particular reason, it’s considered an early withdrawal. The money you take out is taxed as a portion of your normal income and you’ll need to pay a 10 percent early distribution penalty.
You may consider taking 72(t) payments if you want to retire early, but keep in mind that you’ll have to take them for at least five years, or until you’re 59½, whichever is longer. 72(t) payments are much smaller than your standard payment would be if you had waited to start taking withdrawals.
Hardship Distributions. According to the Internal Revenue Service, a hardship distribution are allowed when you have an “immediate and heavy financial need.” If you’ve got a qualifying hardship, you can usually take all of the money you’ve personally invested in your 401(k). Any employer contributions or earned interest, however, often must remain untouched.
Qualifying hardships include, but are not limited to:
- Large medical expenses for yourself or your spouse
- Money required to purchase a new primary home, such as a down payment or funds for closing
- College tuition, room and board for the next 12 months for yourself, your spouse or your dependents
- Funds needed to stop your eviction or the foreclosure of your primary home
- Funeral expenses that you or your estate are responsible for paying
- The cost of some major repairs to your home
Qualifying hardship distributions often still incur a 10 percent early withdrawal penalty, along with being counted as income for the year in which you take them. You’ll also be ineligible to contribute to your 401(k) for six months after a hardship withdrawal. Consider this a last-ditch effort to contain your financial woes, because it’s a costly option.
Penalty-Free Withdrawals. There are a few situations besides electing to take 72(t) payments where you can withdraw your 401(k) funds without penalty. These are usually pretty dramatic turns of events, including the death or permanent disability of the account holder, major medical expenses or a court order giving that money to a divorced spouse or dependent. If you’re affected by a declared national disaster, you may also qualify for a penalty-free withdrawal. The IRS also allows for some extra withdrawals in the case that your contributions are excessive and need to be reduced to avoid a penalty.
Required Minimum Distribution. Your Required Minimum Distribution (RMD) is a different kind of withdrawal — it’s one you’ve got to take or you’ll be penalized. The RMD applies when you’ve retired, but aren’t taking all or most of your schedule distributions from your 401(k). Since the money that went into that account was untaxed, the tax man is getting antsy for his cut — hence the RMD.
This distribution is different for everyone, but it represents the minimum amount you’re required to withdraw from your account every year once you reach age 70 1/2. If you don’t take the full amount, the IRS will impose a penalty of half of whatever funds remain from your required distribution — so if you were supposed to take $24,000 in 2014, but only took $12,000, the IRS would tax the remaining $12,000 at 50 percent.
There is an exception, though. If you’re still working at age 70½, the RMD doesn’t apply to you. You’re free to work as long as you wish and leave your 401(k) untouched, but as soon as you retire, the RMD kicks in.
Saving for retirement can be an exercise in self-control, but it’s important to know how to access your funds if you should need them. You worked hard for your retirement savings, understanding withdrawals can help you make it work better for you.