Getting Money Out of a 401(k) Plan -- the Rules
The best way to take money out of your 401(k) plan depends on three things:
- Your age.
- Whether you still work for the company that sponsors your plan.
- Your 401(k) plan's rules.
Age — Generally, employees are eligible to take penalty-free distributions at age 59 1/2, but the IRS doesn't require employees to take distributions until the calendar year that the employee turns 70 1/2.
You're still employed — Typically, you cannot cash out a 401(k) while you're still working for the sponsoring employer. But you may be able to take out a 401(k) loan or make a hardship withdrawal in certain circumstances. However, as a general rule, should try to avoid this.
Plan rules — Any money taken out of your 401(k) generally falls into one of these categories:
- Regular 401(k) withdrawal — If you don't work for the sponsoring employer and you're older than 59 1/2, you'll pay income tax on the amount you take out, but no penalty.
- Early distribution — You'll pay income taxes and a 10% penalty. But keep in mind that 401(k) assets are generally protected from creditors.
- 401(k) rollover to an IRA — A common strategy when you leave a company. You pay no taxes or penalty. You can leave your money in the 401(k) plan even after you leave, but you can't borrow money or take a hardship withdrawal. You need to take a distribution or roll over your 401(k) to an IRA.
What if you're a 401(k) beneficiary?
If you're the beneficiary of someone else's 401(k), you have different rules that apply to taking money out depending on ages and whether or not your beneficiary was your spouse.
Inheriting from a spouse: Your choices depend on both your age and your late spouse's age. For example, if both of you had reached the 70 1/2 required minimum distribution age, you are bound by RMD rules, although there are several ways to manage that. If you are over 59 1/2 but under 70 1/2, you may be able to roll it over to your own IRA and postpone RMDs until you hit 70 1/2, among other options. Finally, there is another set of rules if you're under 59 1/2. You may be able to access these funds and avoid the 10% penalty even though you are under 59 1/2, but you will have to pay taxes.
Inheriting from a nonspouse: Your choices depend on the status of the person you're inheriting from. If the person had reached 70 1/2, you must continue taking those RMDs, although if your life expectancy is longer, you can switch to that. If the person had not reached 70 1/2, the 401(k) plan may require you to take all of the money out of the plan within five years. Or it may allow you to take the money out in annual amounts over your life expectancy.
This is just a summary; there may be other choices and restrictions. The bottom line is that an error may be very costly, so before making a withdrawal, speak with a financial professional who can advise you on what's best for your tax and financial situation.
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