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You have faithfully contributed to your 401(k) for most of your career. Even with the ups and downs of the market you continued to add to your plan with each paycheck, accumulating a sizable balance. Now you have retired or changed employers and you need cash.
Is there any way to access these funds without paying a 10% penalty?
Leave your 401k where it is. Some 401(k) plans will require you to distribute your funds when you leave your job, if you have a small balance, but this is definitely the exception to the rule. Most of the time, you may leave your 401(k) at your current employer where it will continue to grow tax-deferred until you choose to begin taking distributions or roll over your plan elsewhere.
No distributions means no taxes or penalties. But what if you need the money?
Stay at your job until the year you turn 55. Resign on January 1, if you like. As long as you become age 55 or older during the year you leave your job, you may take penalty free distributions from your current employer’s 401(k). Distributions will be taxable, but unlike early distributions from an IRA, distributions from your 401(k) avoid the 10% early withdrawal penalty if you turn 55 years old or older during the year you left your job.
This rule only applies to the 401(k) of the employer(s) that you left during the year you turned 55 or older. In other words, your previous 401(k)s are still subject to the 10% penalty if you left those employers before you turned 55.
For example, you turned 55 in 2022 and left your job at World Wide Widgets, Inc. to wear flip flops and live out of a Sprinter Van somewhere along the Gulf Coast. Good news: distributions from your current 401(k) avoid the 10% early withdrawal penalty. Distributions will still be taxable as ordinary income.
If you left your job when you were 54 and then decide take distributions from your 401(k), they will be subject to both taxes and the 10% early withdrawal penalty.
Other exceptions to the 10% early withdrawal penalty include:
Death. When you die, your beneficiaries will inherit your 401(k) and may make taxable distributions without penalties.
Disability. If you become disabled, your 401(k) balance will be available to you without the 10% penalty.
Medical expenses. Maybe. If your unreimbursed medical expenses exceed 10% of your Adjusted Gross Income (AGI), the amount that exceeds 10% may avoid the early withdrawal penalty.
Rollover to another qualified plan. Rolling your plan balance over to an IRA or another 401(k) is not a taxable event and avoids the 10% early withdrawal penalty. If you need to make a distribution right now, this won’t help.
However, one option could be to rollover your 401(k) to another 401(k) and take a loan against that plan. Loans generally are not taxable and avoid penalties. Certain conditions apply.
Rollover to an IRA. Another option, rollover your 401(k) to an IRA where you may be able to take penalty free distributions for things like qualified higher education expenses or a first-time homebuyer purchase. Distributions will be taxable, but certain distributions for higher ed expenses or first-time home purchases avoid the 10% early withdrawal penalty.
72(t). Rule 72(t) allows for Substantially Equal Periodic Payments from your 401k that avoid the 10% early withdrawal penalty. Payments are based on the amount of the distribution, your age and an annuity factor determined by the IRS. Be careful on this one. Miss a distribution or take out the wrong amount and the entire SEPP amount could be subject to taxes and penalties.
60-day rule. 401(k) plan owners may take tax and penalty free distributions from their 401(k) after they leave their job if the money is rolled over to an IRA or other qualified plan within 60 days. Strict rules apply. You may only do one 60-day rollover every 365 days. Fail to return the money on time and the tax fairy will impose taxes and penalties. Bippidty Boppidy Boo.
401(k)s and other qualified plans are meant to be long-term retirement savings vehicles. Generally, you want to avoid taking money out of these plans as long as reasonably possible. However, if you must take an early distribution there may be some ways to avoid the 10% early withdrawal penalty. Some strategies like rule 72(t) and the 60-Day rule come with very specific rules and significant consequences if you make a mistake.
Before making any decisions regarding your retirement plan assets consult your tax professional or financial advisor.
To discuss any of the topics in this blog or to learn more about how we can help you Cross The Bridge To A Confident Retirement, please contact me through my web site mikebranch.net, call me directly at 651-379-3935 or email me at mpbranch@focusfinancial.com.