Performing a 401k Early Withdrawal

401k early withdrawal of funds is something that is usually regulated and restricted by employers, and there are several tax penalties to boot. It may be helpful to first define what exactly what a 401K plan is, and the rules and regulations that go along with such a plan. Terminating this plan is not very simple, although there are several more than valid reasons to withdraw the funds when needed.


What is the 401(k)? How Does it Work?

The 401(k) is one of the most popular IRAs (Individual Retirement Account) in use. An IRA is a retirement/investment scheme, which allows individuals to deposit cash into a fund and direct the money to be invested in bonds or securities as per their discretion. 401(k)s are almost exclusively used by companies who want an alternative retirement plan for their employees.

According to several studies, over 70% of large companies (over 100 employees) have put the 401(k) plan into effect, with around a trillion dollars invested in various 401(k) plans.

The basic way that this plan works is that a company will create a plan, with several investment options (including company stock). Employees then contribute a certain amount of their wages into this 401k plan. This amount is to be no more than four to six thousand dollars a year (depending on which year the plan was created in), although employers may also place their own restrictions. The amount paid into the fund is tax deferred, meaning that no tax will be charged on it until the plan matures, or until an early withdrawal. The funds saved in this account are ready to be withdrawn at the age of 59 and a half.


Penalties for 401k Early Withdrawal and the Benefits of the 401k

The 401k is the most popular investment plan for several reasons. One of these is the fact that money invested is tax deferred. This does not only mean that you will not have to pay taxes on it right away, but you are also able to invest your money without losing a large percentage of it to taxes. Another bonus is the fact that most companies will add a percentage to your investment, typically around 25%-50%. However, this is not all hunky dory, and there are reasons why you may want to perform an early 401k withdrawal.

For starters, you do not have complete control over the investment options, as these are regulated by a plan manager. Neither do you have control over the money itself. The 401(k) plan was started over 30 years back, and as the earliest investors in the plans are now withdrawing their funds, they are finding them to be insufficient. According to studies performed using data from the Federal Reserve, the early beneficiaries of such plans are finding themselves unable to maintain their lifestyles, as the savings generated are a mere quarter of what they need.

Therefore, performing a 401k early withdrawal and switching to a different IRA may be a good idea in some cases. It is helpful to note that you can take a percentage of this money out as a loan and use it to pay bills, including medical, legal and educational expenses not covered by your company. Depending on your plan, there may be several reasons for which you can withdraw all the money from the account, including termination of employment, medical needs, imminent foreclosure of property, etc. In almost all cases, the penalty is a 10% tax charge on the total amount.

You may want to speak with the administrator of the retirement plan before you consider an early withdrawal of your 401k, so as to ensure that you can get the most out of your hard earned savings.


Return to the Cheap Investment Page

Click here to Return to Cheapest Places to Retire

feed icon