Accessing your hard-earned retirement savings is not as easy as withdrawing funds from a checking or standard savings account. Instead, accessing your retirement funds requires a process and protocol that former employers, current employers, and participants must follow.
Whether you’re ready to step out of your career and into your golden years, or access your funds early, there are some things you need to know before cashing out your 401(k) plan. Read below to learn about eligibility; taxes, fees, and penalties; and how to get the cash in hand via distributions.
Are You Eligible?
The first question to ask yourself is if you’re eligible for a 401(k) withdrawal. If you’re currently employed, you won’t be able to withdraw from an active plan unless your plan provider allows 401(k) loans, which come with interest rates and fees. If you’re retired or looking to access funds from a previous employer’s 401(k) plan, then you should be able to withdraw your funds, as long as you meet eligibility requirements.
Some requirements to consider include:
- Is the plan active or inactive?
- Are you age 59 ½ or older?
- Are you experiencing a financial hardship?
These questions will help you determine if you’re eligible or not. For example, if you’re over 59 ½, you can start withdrawing funds from your 401(k) plan, and if you’re over 70 ½ – before January 1, 2020 – or 72, you will be required to start taking out minimum distributions each year.
If that’s not the case and you are looking to withdraw funds from your 401(k) due to immediate and heavy financial hardship, you may be eligible to receive funds from your account. Eligible circumstances approved by the Internal Revenue Service include, but are not limited to:
- Expenses for medical care
- Payments on a home to prevent eviction
- Burial or funeral expenses
- Home repairs due to natural disasters
- COVID-19 related hardships
In addition to hardship withdrawals, the SECURE Act 2.0 allows plan participants to withdraw up to $1,000 annually for emergency expenses without paying a penalty fee. Before withdrawing funds, make sure you understand the regulations of the Act and speak with a plan administrator to ensure you’re eligible.
Taxes, Fees, and Penalties
Eligibility is a crucial component to early withdrawals, and if you fall outside of regulations and exemptions prior to age 59½, you may find yourself facing hefty penalties, taxes, and fees.
For example, early withdrawals count as income in the eyes of the IRS, which is subjected to a standard 10% penalty tax. Furthermore, if your withdrawal falls outside of a vested amount, meaning that your company still owns the funds in the account until you reach a specific number of years at the company, you may be faced with additional fees from the IRS and your plan administrator.
If you have $25,000 in an employer-sponsored 401(k) plan and you’re 30% vested in the account, you are only eligible for $16,250. If you’re withdrawing the funds before reaching retirement age, you will be subjected to a 10% penalty, reducing the effective net withdrawal to $14,625 once you’ve paid the fees and taxes on the plan.
When considering early withdrawals, it’s important to understand the financial breakdown of the amount you need in addition to the fees you may have to pay. Once you calculate it down, you may find that an early withdrawal is not financially beneficial for your situation and may need to turn to savings or an emergency fund instead.
If you still find yourself backed into a corner, it’s important to understand the full fee and penalty structure of your plan before making any major or minor withdrawals. Speak with your company’s HR team or plan administrator to understand the ins and outs of your employer-sponsored account before making any rushed decisions.
Required Minimum Distributions (RMDs)
Employer-sponsored 401(k) plan participants can let their money sit in an account until they reach the age of 73, at which point they will be mandated to follow a required minimum distribution (RMD) schedule determined by the IRS. RMD schedules can be deferred if the plan participant is still actively working, but restrictions may apply.
A RMD is the amount of money that must be withdrawn from a retirement account on an annual basis to prevent participants from evading taxes. A RMD is determined by dividing the retirement account’s fair market value by life expectancy, as noted by the IRS. RMDs are then withdrawn by the participant annually and taxed on the income made.
Slavic401k has a calculator to help you determine what your RMD for your 401(k) plan will be and considers the estimated rate of return, account balance, owner’s birthday, and more, to help you determine your annual withdrawals. View the calculator here. Note that failing to withdraw annual RMDs can result in penalty fees from the IRS. Learn more from Employee Fiduciary.
Cashing out a 401(k) can be a process, but following plan administrator and IRS rules and regulations can make it easy and stress-free. If you’re not sure where to start, contact your company’s HR team or benefits specialist to understand the rules associated with your account. From there, you can curate a plan and prepare for your future retirement.