Sunday, June 26

401(k) Early Withdrawal: How to withdraw money from a 401(k) early

A401(k) plan is a company-sponsored retirement savings plan that offers tax benefits to both the employee and the company. Over time, the money accumulated in the account is allowed to grow tax-free. The goal is to put off withdrawing money until retirement.

If you need to, you can take money out of the account before you reach the age of 59 With a few exceptions, the account holder will face a significant income tax bill as well as a 10% penalty.

And, as a result of the early withdrawal, their retirement savings will be permanently depleted.

You may want to consider other options before taking an early 401(k) distribution. And if you do have to make the withdrawal, there are ways to make it less painful financially.

How to withdraw money from your 401(k) early?

You’ll need to fill out the necessary paperwork and provide the requested documents once you’ve determined your eligibility and the type of withdrawal you want to make.

The paperwork and documents required will vary depending on your employer and the reason for the withdrawal, but once you’ve completed everything, you’ll receive a check for the funds requested, hopefully without having to pay the 10% penalty.

Borrowing from a 401(k)

In general, taking a 401(k) loan is preferable to taking an early withdrawal. In essence, you’re lending money to yourself and promising to repay it.

Instead of permanently losing a portion of your investment account, as you would with a withdrawal, a loan allows you to replace the funds, which you can do through payroll deductions.

You’ll need to see if your plan provides loans and if you’re eligible or you could also look into getting a personal loan from another source, such as a bank.

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If a 401(k) withdrawal is your only option, make sure your withdrawal qualifies as a hardship or an exception with the IRS to avoid the 10% penalty.

Substantially Equal Periodic Payments (SEPP)

If the funds are in an Individual Retirement Account (IRA) rather than a company-sponsored 401(k), substantially equal periodic payments (SEPPs) are another option for withdrawing funds without paying the early distribution penalty.

If you are still working for your employer, SEPP withdrawals are not permitted under a qualified retirement plan. If the funds come from an IRA, however, you can begin SEPP withdrawals at any time.

If you have a short-term financial need, SEPP withdrawals are not the best option. You must continue to make SEPP payments for a minimum of five years or until you reach the age of 5912, whichever comes first. Otherwise, the 10% early penalty remains in effect, and you will be required to pay interest on any deferred penalties from previous tax years.

Taxpayers who die (for beneficiary withdrawals) or become permanently disabled are exempt from this rule.

The Internal Revenue Service (IRS) has approved three methods for calculating SEPP: fixed amortization, fixed annuitization, or required minimum distribution (RMD). Choose the method that best suits your financial needs. Each method will calculate different withdrawal amounts.

Is it possible to withdraw money early from a 401(k)?

Yes, if your boss/employer permits it. There are, however, financial ramifications to doing so. Except in the following circumstances, you will owe a 10% tax penalty on the amount you withdraw:

  • If it qualifies as a hardship withdrawal under IRS rules
  • If it qualifies as an exception to the penalty under IRS rules
  • If you need it for COVID-19-related costs
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In any case, the person who makes the early withdrawal will owe regular income taxes on the money taken out for the year. The entire balance of a traditional IRA is taxable. Any money withdrawn early from a Roth IRA that hasn’t already been taxed will be taxed. (Taxes must be paid on the account’s profits, not on the money you put in, which has already been taxed.)

If the money does not fall under one of these exceptions, the taxpayer will be charged an additional 10% penalty on the amount withdrawn.

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