What Age Can I Draw from 401K
You may withdraw funds from your 401K without penalty at the age of 59-1/2 years.
Is there a Penalty for Withdrawing from 401K in 2022?
The usual rule for a 401K, like any tax-deferred retirement account, is that if you withdraw funds before the age of 59-1/2, you will pay a 10 percent penalty over and above whatever income taxes are due on the funds. In other words, in return for the privilege of deferring your taxes, the Internal Revenue Service expects you to defer using those funds until you are close to retirement age. However, as IRAs and 401Ks have become one of the more significant assets held by most people, the government has permitted some types of withdrawals that do not incur the 10 percent penalty. If you can structure your withdrawal to fit into one of these categories, the penalty may not apply. Sadly, however, since your deposits were in pre-tax dollars, you will likely still owe income taxes on your withdrawal.
When Can You Take Out 401K Without Penalty
There are ways to take out money from your 401K without penalty and we will look at them below.
Avoid Making the Withdrawal
If you prepare yourself for potential financial emergencies, you will be more likely to avoid taking a withdrawal from your 401K account. Financial advisors recommend having at least six months’ worth of expenses in a liquid account. You can put it in a money market fund to earn a slightly higher interest rate and still have it easily accessible for emergencies. Another option, if you have excellent credit, is to take advantage of zero percent interest credit offers. So long as you pay the balance off as required, you have what is, in effect, an interest-free loan. If that isn’t available, you can try to obtain an unsecured personal loan from your bank or credit union. This is another option where your credit rating is of paramount importance to get the loan on the best terms from your own financial institution.
You may also be able to obtain a portfolio line of credit if you have a large securities account with a broker-dealer. Your stocks and bonds secure the line and generally have a lower interest rate than personal loans or credit cards because it is securities. However, in a volatile market, your stocks may lose value, which will impact your credit line’s value. Your lender will, especially in fast-moving markets, look at the quality of your securities and the quantity.
Take a Loan from Your 401K
Many financial professionals will oppose the idea of taking a loan from your 401K plan. Nonetheless, such a loan can be appropriate in some circumstances and will, so long as properly repaid, not incur a tax penalty. One of the best times to use a 401K loan is when you need the money for less than a year, and the amount you need is an amount permitted by your plan’s limits. A loan from your 401K is easy and quick to get and is probably the lowest interest rate you can access. Moreover, unless you violate the size limits or the repayment rules, it is not a taxable event and does not impact your credit rating. You can repay the loan over a five-year repayment schedule, but there is no prepayment penalty. You may even, under many plans, be able to make your repayments through payroll deductions.
Most plans permit you to borrow up to the lesser of $50,000 or 50 percent of the assets in your account tax-free. You will pay interest on the loan, which is paid directly to your 401K. Thus you are paying yourself for using your retirement dollars early.
Your most significant risk in taking a 401K loan is that if you leave your job with an unpaid loan, you must either pay the loan in full immediately. If not, you will be back to a taxable withdrawal and the potential 10 percent tax penalty. If you do pay the loan, you can roll over your entire 401K balance into another tax-advantaged account, avoiding the 10 percent penalty.
Use One of the Emergency Exceptions
The IRS permits hardship withdrawals if the withdrawals:
- is due to an immediate and heavy financial need
- is necessary to meet the need (i.e., you have no other way to meet it)
- does not exceed the amount needed
The “need” may include the needs of a non-spouse, non-dependent 401K beneficiary. The withdrawal will be taxed and probably incur the penalty as well, unless
- you are disabled
- you are paying a medical debt that exceeds 10 percent of your adjusted gross income
- you are required by an enforceable court order to distribute money to a divorced spouse, child, or other dependent.
The expenses that will generally qualify include:
- Specified medical expenses
- Costs relating to buying a principal residence
- Payments to prevent eviction or foreclosure
- Tuition and certain related educational costs
- Burial or funeral expenses
- Certain repairs to the employee’s residence
Generally, if you would otherwise be subject to the 10 percent penalty, you will have to pay it for these. However, if you also have an IRA, you can take a penalty-free withdrawal from that account for:
- Higher education
- Qualified first-time homebuyers for up to $10,000
- Any medical expenses for which you did not receive reimbursement that exceed 10 percent of your Form 1040 adjusted gross income
- Health insurance premiums paid while you are unemployed
Know and Follow the Rules
If you’re considering using a retirement account withdrawal, be sure you know and follow the rules to avoid penalties. Also, make sure to know and understand your plan’s rules and regulations since they don’t always simply mirror the IRS rules and regulations. Your plan may, for example, allow for a down payment expense withdrawal, but not funeral expenses. Check with your Human Resources department if you’re not sure. Don’t forget, as well, that sometimes you can achieve what you want most easily and cheapest through an IRA withdrawal rather than a 401K withdrawal. There are a few 401K withdrawals that will avoid the 10 percent penalty; these are:
- Separation from employment after age 55
- Medical expenses above 10 percent of your adjusted gross income
- Your permanent disability
- Taking a series of substantially equal periodic payments from the account
Conclusion – Get Professional Help
As you have seen, taking money out of a 401K account before age 59-1/2 is fraught with traps and twists. If you already work with a financial adviser, this is a problem to discuss with that adviser before you do anything. If you don’t have a financial professional, this might be an excellent time to begin working with one before taking any irrevocable steps.