Times have certainly been rough this year amidst the pandemic. With all that’s going on, finances have probably gotten shaky for us all. Honestly, I wouldn’t blame you if you were considering withdrawing funds from your 401k. Or maybe you just want to retire early and you’re thinking about starting to draw on your 401k? Can you do that? Let’s talk about what a 401k early withdrawal might mean for you.
Are You Thinking of a 401k Early Withdrawal?
It can be tough out there financially and I’m sure if you’re like me, you’ve considered 401k early withdrawal. Before you withdraw those funds though, make sure you do your research. Below you’ll find some info regarding withdrawing from your 401k early.
What Happens When You Withdraw Early?
Taxes and penalties can really cut into any funds you withdraw from your 401k.
You have to be at least 59 1/2 in order to withdraw funds from your 401k or you end up paying the 10% early withdrawal penalty.
However, you can try to avoid the fee if you qualify for an exception or hardship such as:
- leaving your job
- college tuition for you, your spouse, or dependents
- you gave birth to a child or adopted a child during the year
- funeral expenses
Another great way to avoid the penalty is if you rollover your 401k to an IRA or a new 401k account. If it comes to you, then you have 60 days to deposit into an IRA, along with the tax withholding. If a rollover is what you’re considering, make sure to get it done right in order to avoid the withdrawal penalty and income tax.
While investing your money in a 401k is a great way to grow your money in a tax-deferred account, the income taxes will eat into the withdrawal.
So, for instance, if you’re withdrawing $8,000 with an automatic withholding of 20% along with the penalty, you’ll end up getting only about $5,600. Wondering what happened to that $8,000 right?? Well, that’s the income taxes and penalties.
What if You Retire Early and Want to Withdraw WITHOUT Penalty?
Want to retire early? Great! If you decide to retire early and want to do a 401k early withdraw, it’s definitely possible to do so. I’m sure you’re wondering how you can do this. Well, if you want to get your retirement funds early, you can choose a 72t distribution.
When it comes to a 72t distribution, it works like this:
- the distributions must be “substantially equal periodic payments”
- you can be any age to get the distribution
- must receive the payments for a duration of 5 years or until you reach age 59 1/2, whichever is longer
Seems easy enough right? Well surprisingly enough, it actually is.
You avoid the early withdrawal penalty, which is always a plus. The downside? Well, whether you withdraw with or without penalty, you will still be foregoing any of your future growth on the money that you are withdrawing.
The Big Consequences of Early Withdrawal
On top of the penalty and income tax for early 401k withdrawal, you also run the risk of:
- no interest on withdrawn funds
- a higher tax bill
Since you can’t gain any interest on the money once you take it out of the retirement account, you are forfeiting the growth it could have made. Also, the growth of the money in your 401k account can be severely impacted by market stability during the time that you make your withdrawal.
If the market is up, you may have a chance to bounce back from the withdrawal. If the market is down, the chances of any potential rebound within your retirement account are very slim.
When you go to pay taxes the following year, you’ll deal with paying higher taxes since you received a distribution from your 401k. Why? That distribution is considered taxable income. (However, there are ways to avoid it if you’re interested.)
One final thing to consider. Once the money is withdrawn, you can’t protect those funds from creditors. So if you owe a substantial amount of debt, your creditor could claim your money.
401k Early Withdrawal – Are You Doing It?
Before making the decision to do a 401k early withdrawal, please consider what all comes along with that.
The ultimate goal is to build your money. But, if the situation is dire and you must withdraw from your 401k, make sure you understand the tax and penalty portion that you will owe before taking out any money. If you need to, contact a tax advisor for assistance. It’s okay to get as much info and help as you can before making that decision.
Have you considered or are you considering a 401k early withdrawal?
AUTHOR LaTia Longuemire
My name is LaTia Longuemire. I enjoy writing, singing, and cooking in my spare time. My passion is helping others. At this stage in my lifetime, I'm primarily focused on my children. They are everything that keeps my world spinning.