Everyone knows planning for financial security in retirement is important and one of the most common savings methods is a 401(k) plan.

Know Your Options

Everyone knows planning for financial security in retirement is important and one of the most common savings methods is a 401(k) plan.  While 401(k) plans are meant to help you save for the future, sometimes life gets in the way and you may need money now. There are tons of reasons that cash flow might be tight but here are some things you need to know before dipping into retirement funds for a hardship distribution:

  1. Avoid a distribution if possible. Before you take a distribution, find out if you can take a 401(k) loan instead. Many plans offer a loan feature, where without penalty, you can take a loan at a specified interest rate and can generally borrow up to 50% of your vested balance. The loan is paid back through your payroll over a period of no more than 5 years.
  2. You will have to include the distributed funds in your income and pay tax on them at your personal tax rate.  In addition to income tax you may also have to pay a 10% penalty for the early distribution. Your accountant can help you understand the total cost relating to the distribution so it is beneficial to speak with them beforehand.
  3. See if you have any of the following circumstance’s that allow for hardship withdrawal without penalty if you are under age 59½. If you are over age 59½ then you don’t have to worry about the penalty but you will still pay income tax on the distribution. Here is what the IRS lists as penalty exemptions:

Are You Exempt From The Penalty?

The 10% tax will not apply if distributions before age 59 ½ are made in any of the following circumstances:

  • Made to a beneficiary (or to the estate of the participant) on or after the death of the participant,
  • Made because the participant has a qualifying disability,
  • Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the participant or the joint lives or life expectancies of the participant and his or her designated beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59½, whichever is the longer period.),
  • Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55,
  • Made to an alternate payee under a qualified domestic relations order (QDRO),
  • Made to a participant for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the participant itemizes deductions),
  • Timely made to reduce excess contributions,
  • Timely made to reduce excess employee or matching employer contributions,
  • Timely made to reduce excess elective deferrals,
  • Made because of an IRS levy on the plan, or
  • Made on account of certain disasters for which IRS relief has been granted.

Retirement plans can save or cost you significant tax dollars and the rules can be complex. If you are considering taking money out of a 401(k) retirement plan the best thing to do is to talk to your accountant first so that you can avoid the shock of a large tax bill.

Contact Us with Your Questions

If you have questions or need help with your 401K, contact our professionals at The Innovative CPA Group at 203-489-0612.  Or contact us online.