401(k) early retirement questions come to mind for would-be retirees, especially if they plan on retiring earlier than the average person. However, since the 401(k) is a financial instrument for retirement, many early retirees need to consider how penalties and taxes come into play when withdrawing funds from their 401(k) early. Let’s talk about these considerations, and what methods you can implement to use funds from your assets before the mandated retirement age.
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. However, 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
At 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 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
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.
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 to your current one.
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 the 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), which 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 likely 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 if you intend to take this route.
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.
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 see 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 it before the mandated retirement age can reduce the worth it can supply you if drawn from early. 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:
Did we clear your 401(k) early retirement questions? If you have more, we’d love to hear it so we can prepare other resources for you.