Pulling money out of your 401(k) plan if you're not yet 59 and a half should always be your last resort. Borrowing funds against your account balance is the best thing to do, but not all plans have this option. Nevertheless, emergencies do occur, and situations come up where you’re in dire need of money before your retirement age. Here's how to pull money out of your 401(k) and some ways to minimize the penalty.
How to withdraw from your 401(k) with an existing employer:
Whether it's for personal reasons or an emergency, making an early 401(k) withdrawal doesn't have favorable terms. If you’re still working for the company that sponsors your 401(k) plan, you can apply for an Early 401(k) Distribution. This is subject to a 10 percent penalty, and you’ll still be taxed for the amount withdrawn.
Is there a way to make a 401(k) withdrawal with no penalty?
There are certain situations that allow you to make a 401(k) withdrawal without incurring penalties, but you'll still be subjected to income taxes.
1. Regular 401(k) Withdrawal
The best way to make a 401(k) withdrawal without incurring penalties is by leaving your job once you turn 55 or older. For those who work in federal law enforcement or air traffic control, retiring at 50 years of age is still okay since you'll be exempted from the 10 percent tax penalty.
But for the majority of the population, this is not the case. Hence, you'll need to seek alternative means to withdraw money from your 401(k) plan without incurring a 10 percent penalty. Consider the other options listed below if you’re in that kind of situation.
2. 401(k) Rollover to IRA
Rolling your 401(k) account balance to an IRA is one way to avoid early withdrawal penalties. Also, there are no taxes incurred when doing a rollover to an IRA. You'll be allowed to withdraw money from an IRA company of your choice -- taxed annually, depending on the amount you choose to withdraw.
There is a special rule called 72(t) payments that exempts those that have rolled over to an IRA from early withdrawal penalties. However, there are situations where you may incur penalties for any earnings.
You should seriously consider rolling your money over to a Roth IRA instead of a traditional one, as it's much easier to withdraw. In certain instances, your employer may not permit you to do this, so, you’d have to first rollover to a traditional IRA then later convert it to a Roth IRA.
3. Hardship Withdrawal Option
Only consider this option if you're in urgent financial need for situations that can't wait, like paying college tuition or medical expenses. A hardship withdrawal is not subject to any penalties, but you'll still have to pay income tax.
The Secure act of 2019 even allows individuals to withdraw a sum of up to $5,000 as hardship withdrawal to prepare for costs associated with a birth or adoption. The only eligibility required for a hardship withdrawal is if you’re in heavy financial need and the amount you’ve requested satisfies the financial need.
You should consider other options before withdrawing money from your 401(k) plan if you're not at the retirement age yet. The decision to make an early withdrawal from your 401(k) plan should not be taken lightly as it can impact your future. But if you've exhausted all your other alternatives, then you do have the option to pull out money from your 401(k) plan.