Retirement plans are, generally speaking, intended for when you retire. However, sometimes you find yourself needing access to those funds in your 401(k) or IRA. You can gain access to your retirement account early through hardship distributions, early withdrawals, or even loans.
While the IRS has their own rules, your employer can make certain specifications or requirements within the scope of those rules, so first and foremost, check with the Summary Plan Description from your employer-offered or individual plan.
It will help if you understand these different access points and what penalties accompany them before the need arises.
Accessing Distributions Early
You can take distributions before retirement in certain cases, which will all be outlined in your summary plan. These can include:
Hardship distributions: This is made due to an urgent financial need and you are limited to withdrawing only however much is required to meet that need. You will pay taxes on this distribution and will not pay it back into your account. Both 401(k)s and IRAs can have hardship distributions and will have their own provisions of if or when you can take one.
Early withdrawals: IRA and 401(k) withdrawals are early if done before age 59 ½. Withdrawing before this age means that you will be taxed 10% of the total amount you removed, but there can be exceptions to work around the tax.
401(k) holders who retire or lose their job at the age of 55 can avoid the 10% early withdrawal penalty, but only with the 401(k) from their most recent employer.
Loans: Like any other loan, a retirement loan must be repaid. You will not pay taxes if you follow the repayment schedule. The Summary Plan Description of your retirement plan will have more information specific to your 401(k). IRAs do not allow loans.
Penalties for Early Withdrawal from Your Retirement Account
Your 401(k) or IRA are intended for your retirement, so they shouldn’t be the first place you go to for financial assistance. After you exhaust your other options, an early withdrawal can be worthwhile.
The IRS generally permits hardship withdrawals without paying the 10% penalty fee, but there are exceptions. These include buying your principal residence, tuition expenses, preventing eviction or foreclosure, or funeral expenses. If you need to withdraw for one of these reasons, a loan might be the better option. This way, you’re able to pay it back without owing any taxes.
If you have to pay medical bills that exceed 7.5% of your adjusted gross income, then there is no penalty. Likewise, if you end up living with a disability, you can also withdraw early without paying the tax penalty.
Again, these provisions will be further detailed in your employer’s plan. You should make yourself acquainted with them prior to a real emergency.
Regular Distributions During Retirement
After retirement, regular distributions with a traditional 401(k) or IRA are taxed as income, unlike Roth 401(k)s or Roth IRAs. Roth accounts have already paid income tax on the contributions, so there’s no tax upon withdrawal or distribution.
When you receive distributions from your 401(k), the resulting balance remains invested according to the investment portfolio. The length of time during which you can receive payments, and the amount of that payment, depends on how well the portfolio performs.
When it comes to IRAs or 401(k)s, you will have to pay penalties for withdrawing early—or for not withdrawing after the age of 72. You must take the minimum amount of distributions by April 1 of the year after you turn 72. Failing to do so means you pay a hefty penalty of 50% on the amount you did not withdraw.
Your required minimum distribution is based on your life expectancy and your account balance. While you can always withdraw more than the minimum, you cannot take less without paying a penalty.
Get Help With Retirement Account Withdrawals
Like most things related to the IRS, there are exceptions and rules for every scenario. Don’t wait to set up a financial plan to help you meet your retirement goals and to avoid paying unnecessary fees. Contact us to find an experienced financial advisor who can help you determine the best path for your situation.