401(k) early retirement questions come to mind for would-be retirees, especially if they plan on retiring earlier than the average person. Let’s talk about the penalties and taxes, and what methods you can implement to use funds from your assets before the mandated retirement age.
In this article:
- Your Age and 401(k) Early Retirement Withdrawals
- 401(k) Early Retirement Strategies You Can Use to Tap into Your Assets Early
401(k) Early Retirement Rules You’ll Be Glad to Know
Your Age and 401(k) Early Retirement Withdrawals
Retirement can’t begin soon enough for a lot of us. Of course, setting up a 401(k) retirement plan should result in financial independence at an advanced age. But what happens if you end up retiring early? Would you be able to enjoy your retirement benefits?
Tapping into your account at the wrong time can incur you a 401(k) early withdrawal penalty. Let’s talk about ages to see how much is taxed on 401(k) early withdrawals.
1. Age 55 and Below
Should you wish to retire early during this age range, the government treats early 401(k) withdrawals as taxable income and thus, you incur an income tax. There’s also the 10% early withdrawal penalty. These deductions can cut the value of your withdrawal by as much as half.
The only times you’re entitled to tax-free withdrawals in this age range is when you’ve become disabled, make a small deduction for medical expenses, a Qualified Domestic Relations Order (QRDO) is used, or if your beneficiary withdraws from your account if you die.
2. Age 55 to 59 and 6 Months
This is a little bit earlier than the normal retirement age. The same penalties apply, but there are exceptions. When you leave employment at, or after the year you turn 55, 401(k) withdrawals are still taxable income. However, at this point, your withdrawal is free from the penalty charge, leaving you with more money in your nest egg.
Please note that you will only be able to withdraw from the 401(k) account of your current job. You will need to roll over funds from your other 401(k) accounts from previous jobs, whether full-time work or part-time work, to your current one. This includes Traditional IRA plans and other retirement plans from your previous employment.
3. 401(k) Withdrawal at Age 59 1/2 to 70
The point when you reach 59 and six months is the time you can make withdrawals without penalties from your previous works’ 401(k) assets. If you’re still working, you will need the guidance of your 401(k) administrator to make withdrawals penalty-free. Keep in mind, however, that the government still considers these withdrawals as taxable income.
4. Age 70 and Above
When you’re 70 or older, the IRS mandates that you need to make Required Minimum Distributions (RMDs) or regular withdrawals. However, you can choose to delay these withdrawals until April of the year you retire. If you have a 5% stake in your company, however, you will be forced to take those tax-deferred withdrawals.
401(k) Early Retirement Strategies You Can Use to Tap into Your Assets Early
1. Make Substantially Equal Periodic Withdrawals
The IRS issued Rule 72(t) allows account holders to withdraw penalty free, provided they take them in at least 5 substantially equal periodic payments or SEPPs. This period can run for as long as 5 years. However, you need the advice of a specialist for help on how to set up a 72(t) distribution. Again, the amount you withdraw will incur an income tax deduction. You should ask the advice of an expert to help you avoid incurring a 72(t) distribution penalty if you’re thinking of this option.
2. Rollover Your 401(k) to a Roth IRA
You can convert your 401(k) balance to a Roth IRA and then withdraw the money penalty-free. However, you can only tap into these funds 5 years after you roll them over. So please, make adjustments in your retirement savings if you intend to take this route. It’s better to talk to an expert about this to avoid any mistakes when you decide to roll over your 401(k) retirement to a Roth IRA.
3. Make 401(k) Early Retirement Withdrawals at Age 55
If you can make compromises to your early retirement life plans, then try retiring at 55, when you can make penalty-free withdrawals. It’s not the same as retiring at 40, but at least you’ll have more value with your withdrawals.
4. Opt for a 401(k) Loan
When you absolutely must tap into your 401(k), you can borrow around 50% total of your 401(k) balance or $50,000, depending on which is lesser, from your nest egg. What’s great about this is that the interest you pay goes back to your 401(k). However, there are stiff penalties if you leave your current employment and do not repay your loan within 90 days. This way, you can use some of your 401(k) retirement but still get to repay it for future use.
5. Make Hardship Withdrawals
For the most extreme needs, you can make hardship withdrawals from your 401(k) if there are provisions for it in your plan. Both the income tax and penalties apply if you’re below 59 and 1/2. This option only becomes available if you’ve exhausted other loans under your plan and you have no other financial recourse to meet the need. You can also only withdraw an amount less than the specific value you need.
A majority of the working population sees retirement as the time their freedom resets. The 401(k) plan is a tool to supply some of the needs of the retired life. However, tapping into your retirement savings before the mandated retirement age can reduce how much it can supply you later on. If you can accept this caveat, your 401(k) can be a good resource you can use to impact your life now.
Learn about the rules for 401(k) withdrawals by age in this video:
Were your questions about 401(k) early retirement answered in this article? If you have more to ask, please write them in the comments section.
Editor’s Note: This post was originally published on June 22, 2018, and has been updated for quality and relevancy.