When times are tight, and you need the cash, you may be tempted to raid your 401K funds to make ends meet. Or it may be that you've been laid off (or you company has ceased to exist) and they need to distribute your funds. Here are your options for a 401K, as well as the tax implications of each.
Still Employed - Hardship Withdrawals
"While you are employed by the company that offers a 401(k), you usually have
an opportunity to access savings under certain hardship conditions. The
drawback however, is that qualifying for this provision can be difficult. Just as
the IRS has its list of qualifying financial hardships (medical expenses or
disability), individual plans often do as well. That means you must qualify under
both sets of rules, which may be more difficult. Another drawback of a hardship withdrawal before age 59 ½, is the 10% penalty on whatever you’ve withdrawn. The withdrawal is also taxed as income. Taxes and penalties can make a hardship withdrawal expensive."
Still Employed - Non-Hardship Withdrawals
"Not every plan allows non-hardship withdrawals. If yours does, you have an
opportunity to take money out of your account and redistribute it as you see fit.
Generally the best bet is to roll the amount into an IRA. That way you avoid taxes,
and you have a larger range of investment options, usually with lower
administrative fees. Rollovers made directly to the owner of the 401(k) must be
reinvested in a qualified plan within 60 days or be faced with a 10% penalty."
Still Employed - Loans
"If you’re in a bind, a 401k loan may be your only remaining option. A loan from your
401(k) allows you to borrow against your savings. Some use restrictions similar
to those for hardship withdrawals. The loan must be paid back, usually within
five years, and loans cannot be rolled over into an IRA. However, if you leave a
company and still have an outstanding 401(k) loan, you’re oftentimes required
to pay it back in a short amount of time, usually one to two months."
No Longer Employed with the Company - Lump Sum Withdrawal
"If you are under 59 1/2 then you will face a 10% early withdrawal penalty as well as federal and state income taxes. So you will likely lose 40% or more to the government by going down this path. The IRS mandates that 20% of the withdrawal be withheld from the payment (but this is clearly not enough to cover the tax bill, so don't spend it all).
If you are over 59 1/2 then the penalties won't apply, but you will still have to report all the withdrawals as income, which could push you into a higher income tax bracket if the retirement savings are substantial.
No Longer Employed with the Company - Rollover to IRA
This is probably the ideal option in most cases because it will avoid taxation on the withdrawal. The ideal scenario is a direct rollover between the two trustees, where you never touch the money. Once the money is in the IRA, you have a few withdrawal options depending on what you age is.
Source 1
Source 2
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The content on this blog (www.acollinscpa.blogspot.com) is my personal opinion based on my study and understanding of tax laws, policies and regulations. It’s provided for your private, noncommercial, educational and informational purposes only. It’s not a recommendation or endorsement of any company or product. It should not be relied upon as specific tax advice for your personal situation. I strongly suggest that when it comes to filing your taxes, you get additional, professional guidance from individuals who are familiar with your specific circumstances. Those who choose to rely solely upon the information on this site do so at their own risk and peril, and cannot hold the author liable in any form or fashion.
IRS CIRCULAR 230 DISCLOSURE REQUIREMENT: IRS Circular 230 requires us to notify you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding tax penalties that may be imposed by law.
IRS CIRCULAR 230 DISCLOSURE REQUIREMENT: IRS Circular 230 requires us to notify you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding tax penalties that may be imposed by law.
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