Everybody plays the fool on the stage of life – there is no exception to the rule. The trick is to not make too many repeat performances. That is an amalgam of quotes culled from Shakespeare and 1970s soul group The Main Ingredient, but I think you get the gist. There are some foolish acts in life that bear more consequences than they are worth. Like early 401k withdrawals when you can withdraw from 401k without penalty.
I had a 401k plan that I converted into an annuity some years ago. It was the most foolish thing I could have ever done. I learned of so many other things I could have done after I did it.
Worse, I basically robbed myself of a small supplemental income in my retirement age.
But that is another story.
Usually, you must be 59 1/2 before you can even consider withdrawing from a retirement account without incurring tax or early withdrawal penalties.
What I have learned the hard way is that there are many conditions upon which you can withdraw from a 401k penalty-free.
Still, these early retirement withdrawal conditions are exacting and depend on the rules of your 401k plan.
First, let’s breakdown what a 401k is.
What is a 401(k)?
A 401(k), which can also be stylized as “401k,” is an employer-sponsored retirement plan.
Basically, your 401k is an employer sponsored retirement plan that will provide you with a supplemental income during your retirement.
You will only pay taxes on your 401k plan when you start withdrawing payments from it during retirement.
However, there are serious penalties for withdrawing from your 401k before the age of 59 ½.
Early Withdrawal Penalties
If you withdraw from your 401k plan before the age of 59 ½ then you will be charged a 10% penalty.
Think about it – if you withdraw $3,000 early, then you automatically pay $3,000 in early withdrawal penalty fees.
This is a provision mandated by the IRS to discourage early withdrawal.
However, here several exemptions where you can withdraw from 401k without penalty:
- Making a Down Payment on a Home
- Coronavirus Medical Relief
- Financially Overwhelming Medical Expenses
- 401k Rollover into new Retirement Account
- Active Duty Military Service
- The Rule of 55
- Permanent Physical Disabilities
- Various Financial Hardships
Making a Down Payment on a Home
Are you an aspiring homeowner, enacting significant façade repair and rehabilitation, or building a home? Well, then you can withdraw from 401k without penalty to finance a down payment.
You will have to borrow from your 401k retirement account plan in the form of a loan. The loan amount will be tax and penalty free.
You can only withdraw a loan amount that is equivalent to half of your 401k account value. Still, this amount can’t exceed a value of $50,000.
The loan must be paid back with interest within a period of 5-years. The terms for repayment could be extended depending on your personal circumstances.
If you lose your job you will have to pay back the loan in full before your next tax return date. And, you’ll have to pay the 10% early withdrawal penalty too if you are under the age 59 1/2.
Coronavirus Medical Relief
The CARES Act was ratified in March 2020 after the gravity of the coronavirus became globally undeniable.
Under the CARES Act financial relief payments and eviction protections were enacted to help Americans affected by the pandemic. (However, these payments and protections are ending imminently)
Now, you can withdraw from 401k without penalty if you have been personally affected by the pandemic.
If you and/or a loved one has contracted the coronavirus and are suffering extreme financial difficulty, you can borrow $100,000 from your 401k. The usual limit is $50,000 but has been doubled due to the pandemic.
The 10% early withdrawal penalty is automatically waived under the auspices of the CARES Act.
You have until September 23, 2020 to opt into this penalty-free withdrawal option. It may also be possible to get extensions on repayment terms.
Financially Overwhelming Medical Expenses
Were you aware that the #1 reason for most personal bankruptcy filings were financially overwhelming medical debts?
If your medical expenses exceed 10% or more of your annual adjusted gross income, you can withdraw from 401k without penalty.
401k Rollover into new Retirement Account
If you are leaving one job for another you can withdraw from 401k without penalty.
Your 401k can’t be held hostage at one job just because you are leaving for another.
You should be able to even withdraw the money in your 401k during the 60-day rollover transiton period ostensibly as a loan.
Just make sure that you have repaid the money back into your account, in full, within the 60-day rollover period.
Active Duty Military Service
If you are currently an active duty military service member, you can withdraw from 401k without penalty.
Qualified active duty military service and reservists who have been called to active duty status for 180 days or more are eligible.
The Rule of 55
Are you over the age of 55 and recently retired? Or, are you 55 and were fired from a job from your employer?
As long as you are age 55 or older you can withdraw from 401k without penalty. Still, there is a catch – your employer must have a 401k retirement plan sponsoring you.
If these conditions apply to you then you can cash out your 401k into a lump sum payout. And, you won’t incur a single cent in penalties.
Still, it’s called, “The Rule of 55,” for a very good reason.
You must be at least 55 or older to withdraw from your retirement fund without penalty.
You can’t be 54 years old or 54 years old and 11 months trying to withdraw from your retirement account without penalty.
Try doing this before the age of 55 and you will have plenty of financial worries later.
Permanent Physical Disabilities
Have you recently become permanently disabled? Then there will be no penalty for you if you withdraw from your retirement plan early.
Of course, you will have to provide medical documentation attesting to your disability.
Financial Hardship Withdrawals
Depending on your employer and retirement plan contract stipulations, there are various qualifying conditions you can withdraw from 401k without penalty.
Along with buying a house, these financial hardship withdrawal conditions could include:
- Funeral expenses
- Prevention of home foreclosure
- Paying tuition expenses
- Various home repairs
- Medical expenses
Each retirement plan has its own criteria determining what is a, “financial hardship,” according to employer rules.
For example, your employer may allow you to withdraw for building a house or medical expense, but not for paying tuition.
Talk to Your 401k Plan Administrator
You and your employer may have distinctly different interpretations of what a financial emergency is.
Talk to your 401k administrator and detail your need. Never assume your circumstances warrant a penalty-free withdrawal.
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Allen Francis was an academic advisor, librarian, and college adjunct for many years with no money, no financial literacy, and no responsibility when he had money. To him, the phrase “personal finance,” contains the power that anyone has to grow their own wealth. Allen is an advocate of best personal financial practices including focusing on your needs instead of your wants, asking for help when you need it, saving and investing in your own small business.