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How Can I Take Out My 401k Money Without Penalty
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Taking early withdrawals from your 401(k) may sound like a tempting idea at first—it’s your money, after all. But once you know the meaning, you may feel differently.
There are two types of 401(k): traditional and Roth. The traditional option allows you to set aside retirement dollars on a tax-deferred basis, meaning your taxable income is reduced to the amount you set aside during the year. Your money is tax-deferred until the tax code allows you to start cashless withdrawals after age 59 ½.
With the Roth option (not offered by all employer plans), your money is also tax-deferred, but your contributions are made after-tax. This means your current taxable income doesn’t go down, but you don’t have to pay tax on withdrawals in retirement as long as you’ve held the account for at least five years.
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Matching employer contributions (if any) are deposited into a traditional 401(k) account, and you’ll pay taxes on any distributions taken, even if you choose to roll your money over to a Roth 401(k).
If you’re considering taking the early plunge into a 401(k) and other options that may be the best for your financial needs, here’s what you need to know.
An unexpected job loss, illness, or other emergency can devastate a family’s finances, so it’s understandable that people might consider withdrawing from their 401(k) right away. Read carefully, because the decision can have a long-lasting effect on your dreams of a good vacation.
Withdrawing money from your traditional 401(k) should be your last resort, as distributions before age 59 ½ will be taxed as income by the IRS, plus a 10 percent early withdrawal penalty. This penalty is designed to prevent people from withdrawing from their retirement accounts early.
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Withdrawals of Roth contributions are generally tax-free and penalty-free (as long as the withdrawals are made at least five years after the tax year in which you made the Roth 401(k) contribution and you are 59 ½ or older). Because the dollars you donate are after tax. Be careful here because the five-year rule replaces the 59 ½-year rule used for traditional 401(k) rollovers. If you don’t start contributing to a Roth by age 60, you can’t take a five-year tax deduction even if you’re over age 59 ½.
You can take early withdrawals from a Roth 401(k) before age 59 ½ if you haven’t met the five-year rule above, but with a warning. Because your deductions must include both your personal contributions and the income on those contributions, your deductions must be allocated based on the percentage of each component in your portfolio. So even if all your contributions are tax-free, the interest on those contributions will be taxed as ordinary income and subject to a 10% tax.
If your employer’s plan allows it, it’s another way to access your hard-earned money from a traditional or Roth 401(k) to meet “immediate and urgent financial needs.” Such withdrawal completely reduces your portfolio income and you are taxed as above.
Tax laws do not allow you to repay this amount or “return” it to your account after you have completed the hardship and are in good financial standing. After you withdraw such money, some companies prohibit you from contributing to the plan for six months or more, increasing your retirement savings loss, especially if you miss the company match.
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For those thinking of bailing out, remember that a 401(k) is meant to provide money for retirement and should not be used for other purposes unless your situation is dire.
Your plan may restrict or limit withdrawals to employee contributions only. Some plans include income or employer matching contributions as part of the hardship deduction.
Additionally, IRS rules state that you can only get back what you need to meet your needs, although the total amount claimed may include “any amount necessary to pay any federal, state, or local income taxes or penalties expected as a result of the distribution .” . “
“A 401(k) plan — even one that allows for hardship — may require the employee to cover all other expenses, including attendance.
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