- 401(k) accounts are governed by two sets of rules. One set of rules is found predominantly in section 401(k) of the IRS code. The second set is set by the company and the plan administrator. Just because something is allowed by the IRS does not mean that it is allowed by the plan itself. You must check the details of your plan to determine what will be allowed. Many people assume because something is legal or allowed by the IRS, their specific plan must allow it. That is not true.
- The assets within a 401(k) account are the sole property of the participant. As such, they are under the participant's control and can be withdrawn. However, there are limits and rules regarding such withdrawals, including the possibility that the funds cannot be withdrawn while the participant is still employed by the company that sponsors the 401(k). In addition, withdrawals taken before age 59 1/2 may result in hefty penalties by the IRS.
- All withdrawals regardless of age from a 401(k) account are taxable as income. There is, however, an exception for funds contributed with money that already was subject to taxes. This is uncommon.
So, the importance of tax planning grows as the amount of the withdrawal grows. For example, someone earning $75,000 for the year who takes a $30,000 withdrawal will actually owe taxes on $105,000 for the year.
Withdrawals taken from a 401(k) account before the age of 59 1/2 are subject to a 10 percent tax penalty in addition to being counted as ordinary income. For example, a withdrawal of $30,000 would result in a $3,000 penalty, and taxes would be due on the entire $30,000. - Although the actual trades within a 401(k) account must be executed promptly as per the plan document, withdrawals are processed according to the plan rules and may only be allowed at certain intervals. For example, a plan may only allow funds to be distributed quarterly, meaning the withdrawal could take months to be received.
- Many 401(k) plans provide for a penalty to be imposed for any plan participant who takes a withdrawal while still employed with the company. Penalties may include being banned from further participation in the plan, such as prohibiting contributions from paychecks, for a certain period of time, usually one year.
- For 401(k) account owners who are over the age of 59 1/2 and who are either no longer employed with the plan sponsor company, or whose plans do not have rules against withdrawals or penalties, may benefit from using their own savings instead of incurring debt. However, caution should be exercised because drawing down retirement funds can have lasting consequences.
- Many plans offer an option to take a loan from a 401(k). This feature may be more advisable than an actual withdrawal for most participants.
- Advertisement -
- Advertisement -