If you’ve made it to the part of your retirement-planning journey where you’re now ready to start withdrawing your hard earned money from your retirement account, then congratulations! After years of hard work and saving you’re ready to start enjoying all that retirement has to offer. And if you’re still in the middle of your retirement saving journey, or even right at the beginning, it’s still important to be aware of the rules and regulations surrounding how and when you can start taking money out of your 401(k) account. So while you should always consult a tax or financial planning professional before making any retirement decisions, the below should provide a helpful starting point for understanding how to withdraw money from your 401(k).‍

Early Withdrawal

Because the 401(k) is designed to help individuals save for retirement, you cannot withdraw funds from your account before the age of 59 ½ without paying a 10% penalty. This 10% penalty is in addition to the income taxes that you would normally need to pay as part of a 401(k) distribution, and therefore it is often very costly and inadvisable to withdraw money from a 401(k) before this age. And in some cases, employers will not even allow employees to make early withdrawals, making the entire decision moot.  

That being said, there are some exceptions to the early withdrawal penalty. These include the following, some of which can be applied to yourself, your spouse, your dependent, or your beneficiaries:

• Medical care 
  

• Costs related to the purchase of a primary residence (excluding mortgage payments)

• 12 months of tuition and related educational fees and expenses for postsecondary education

• Payments to prevent foreclosure or eviction on your primary home

• Funeral expenses; and

• Some expenses related to repairs for your primary residence
  

Along with these specified exceptions, there is another exception for “immediate and heavy financial needs.” If an exception applies, then you will still have to pay the income tax associated with your distribution. You can also withdraw up to $5,000 for expenses related to birth or adoption of a child under the 2019 SECURE Act. The IRS has the full list of exceptions, but if you believe yourself to fall into one of these exceptions it’s best to check with a financial professional.  

Once you, and hopefully your financial professional, have decided (1) whether you can or should take an early withdrawal; and (2) does an exception apply, the next step will be filing the relevant paperwork with your employer. Generally, this paperwork looks different across companies, so make sure that you are filling out all of your company’s required forms. Make sure to contact your company's HR department to confirm you have the right forms.

If you’ve decided that you would like to access the funds in the your 401(k) for one reason or another, but don’t want to actually withdraw the funds due to the penalty, there is still a way that you can “access” your funds. The main way to do so is to take out a 401(k) loan. In this scenario, you are not actually withdrawing the funds from your account, and you’ll have the opportunity to replace the borrowed funds from future paychecks. As with an early withdrawal, you’ll first need to confirm that your plan allows for a 401(k) loan, and of course should make sure that the terms of the loan make sense for you and your retirement plans.

Penalty-Free Withdrawal

As we noted above, the recommended way to withdraw your funds from your 401(k) is to avoid the 10% penalty by waiting until you are the required age. Currently the two relevant ages are 55 and 59 ½.  

Under what's known as the Rule of 55, provided your employer provides such an option, you may avoid the 10% penalty if you start your withdrawals after leaving your job at the age of 55 or above. You should know that your employer may impose additional restrictions on how you can take an early withdrawal, so as always it's important to check. Importantly, the reason for your departure does not matter, whether you were laid off, fired, or just quit. Like with all other traditional 401(k) distributions, you would have to pay normal income on your distributions, but it would still save yourself the 10% penalty.  

If your company or plan doesn’t allow for a Rule of 55 withdrawal, then the way to avoid paying the 10% penalty is to simply wait until the currently mandated age of 59 ½. It is important to note that while 59 ½ is the first age at which you can start to make withdrawals, you are not required to receive distributions from your account until after you turn 72, at which point you are required to take a minimum annual distribution (the government’s policy reason for this required minimum being that, since you finally pay tax at distribution, that you should only be able to defer your taxes for so long).  

The good news is that when you do decide you are finally ready to start taking distributions from your 401(k), all you need to do is log-in to your plan’s online system (or contact it’s account administrator) and request your withdrawal. If you’re unsure who this is (or it’s been a while since setting up the account!) your company’s HR department is a great place to start. When you make your distribution, if it is a traditional 401(k) you will owe income taxes (as opposed to if you have a Roth 401(k), which we described in detail here). Therefore, before making any decisions about, or receiving any distributions from, your 401(k), it’s important to consult with a financial professional and confirm how much of your distribution you should set aside in order to pay the taxes.  

As we’ve covered, the ideal situation for withdrawing from your 401(k) is to wait until you are the appropriate age, generally 59 ½, in order to avoid paying a 10% penalty. That being said, we understand that often life happens and it’s necessary to pay for an unexpected expense. If you find yourself needing to leverage the assets in your 401(k), make sure consider all options before simply taking the money and with it, the early withdrawal penalty. This could include a hardship exception, a 401(k) loan, or otherwise acquiring a personal loan. Often times these will be a preferable outcome to paying the penalty. Whatever you do, going through all of your options with your financial professional will help make sure you start your retirement on the right foot.

To learn more about the most popular types of retirement accounts, including the 401(k), check out our blog post on the topic here.

Sunbound is the best way to pay for senior living. If you want to learn more about how Sunbound can help make senior living more affordable for residents and easier to manage for communities, email us at info@sunboundhomes.com or request a demo here. Sunbound is on a mission to make senior living more affordable for everyone.