Since the inception of 401(k) plans in 1980, many companies have offered defined contribution plans as a benefit to their employees. In the process, many Americans have used 401(k) plans to save for retirement with pretax dollars and employer match funds.
In an emergency, you may need to tap those funds, but getting money out of your company’s 401(k) plan can be especially tricky before you reach the official distribution age of 59 ½. A financial professional can help you determine which of the many withdrawal options is most suitable for your situation.
The three most common ways to access 401(k) funds are hardship withdrawals, non hardship withdrawals and loans. Here’s what you need to know about these important 401k withdrawal rules.
Hardship 401k Withdrawals
While you are employed by the company that offers a 401(k), you usually have an opportunity to access savings under certain hardship conditions. The drawback however, is that qualifying for this provision can be difficult. Just as the IRS has its list of qualifying financial hardships (medical expenses or disability), individual plans often do as well. That means you must qualify under both sets of rules, which may be more difficult.
Another drawback of an 401k hardship withdrawal before age 59 ½, is the 10% penalty on whatever you’ve withdrawn. The withdrawal is also taxed as income. Taxes and penalties can make a hardship withdrawal expensive.
Not every plan allows non-hardship 401k withdrawals. If yours does, you have an opportunity to take money out of your account and redistribute it as you see fit. Generally the best bet is to roll the amount into an IRA. That way you avoid taxes, and you have a larger range of investment options, usually with lower administrative fees. 401k rollovers made directly to the owner of the 401(k) must be reinvested in a qualified plan within 60 days or be faced with a 10% penalty.
If you’re in a bind, a 401k loan may be your only remaining option. A loan from your 401(k) allows you to borrow against your savings. Some use restrictions similar to those for hardship withdrawals. The loan must be paid back, usually within five years, and loans cannot be rolled over into an IRA. However, if you leave a company and still have an outstanding 401(k) loan, you’re oftentimes required to pay it back in a short amount of time, usually one to two months.