It is generally not advisable to withdraw funds early from your 401(k) due to significant penalties for doing so. If you take funds out of your 401(k) before you reach the age of 59 ½ you will be subject to a 10% penalty levied by the Internal Revenue Service (IRS). However, if you are still looking to withdraw early from your 401(k) you should check to see if you may qualify for an exemption which can allow you to avoid the IRS penalty.
Equal periodic payments
If you have stopped working but have not reached the age of 59 ½ you may be able to take early withdrawals from your 401(k) if you agree to take “substantially equal periodic” payments which will continue for life. The payments will have to remain the same for the first five years or until you reach 59 ½ years old.
Leaving your job
You will also be exempt from the IRS penalty if you leave your job at the age of 55 or older. However, this exemption can be taken starting at 50 years of age if you are employed in federal law enforcement, customs border protection, air traffic control or federal firefighting.
Divorce
You may be able to obtain an exemption if the court in your divorce case has ordered you to divide the assets in your 401(k) between you and your spouse.
Disability
In the case of becoming disabled, the IRS may exempt you from the usual early withdrawal penalty.
Rollover
Another option to avoid the IRS penalty is to rollover your 401(k) account to an Investment Retirement Account (IRA) or another 401(k) account. However, this must be done after you have left your job to begin working at another job. Note, you must do the rollover within 60 days after you have left your employment. Also, you should be aware you may incur tax liabilities depending upon what type of retirement account you rollover to.
Beneficiaries
Early disbursements of funds from your 401(k) may be exempted from the usual IRS penalty if the funds were transferred directly to your beneficiaries or estate in the case of you passing away.
Giving birth or adoption
It is possible to receive an exemption for up to $5,000 for early withdrawal if you have given birth or adopted a child within the same year.
Disaster relief
The IRS can provide you with exemption from the usual 10% penalty if you have been a victim of a natural disaster such as a fire or hurricane.
Military reservists
In the case of being called to active duty as a military reservist you may qualify to obtain an IRS exemption from the penalty for withdrawing funds early from your 401(k).
Check with a professional financial planner
The pros and cons of taking an early withdrawal from your 401(k) will depend on your specific circumstances and situation. In some cases, there may be other financial options available which you may not be aware of. Speaking with a financial planning professional can help you make the right decision.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.
In addition to rolling over your 401(k) to an IRA, there are other options. Here is a brief look at all your options. For additional information and what is suitable for your particular situation, please consult us.
- Leave money in your former employer’s plan, if permitted.
a. Pro: May like the investments offered in the plan and may not have a fee for leaving it in the plan.
Not a taxable event.
2. Roll over the assets to your new employer’s plan, if one is available and it is permitted.
a. Pro: Keeping it all together and larger sum of money working for you, not a taxable event.
b. Con: Not all employer plans accept rollovers.
3. Rollover to an IRA.
a. Pro: Likely more investment options, not a taxable event, consolidating accounts and locations.
b. Usually fee involved, potential termination fees.
4. Cash out the account.
a. Con: A taxable event, loss of investing potential. Costly for young individuals under 59-1/2;
there is a penalty of 10% in addition to income taxes.