401k Early Withdrawal…only as your very last resort
Do NOT Seriously Consider 401k Early Withdrawal
You do not want to consider a 401k early withdrawal unless you face a serious emergency or a monumental expense you cannot meet any other way. A 401k early withdrawal represents your last resort; do not consider it until you have exhausted all your other options, consulted with a professional financial planner, and looked very carefully at all your assets and resources.
In fact, the IRS stipulates the conditions under which you may take a 401k early withdrawal without penalty:
· The death or permanent disability of the plan participant
· You have reached age 55 and have left or retired from the company that maintained your 401k. “Left” would include both fired and quit, in which case the company either would encourage or would require you to collect or rollover all the funds in your 401k. Some companies demand that you liquidate your 401k within 60 days of your separation from service, and many charge administrative fees after the sixty-day limit.
· You are receiving your retirement funds under an arrangement for “substantially equal payments” over a lifetime. At least in theory, this exception would apply if you met the criteria for retirement or you had become permanently disabled. The difference here turns on the distinction between a lump-sum distribution and the agreement to accept periodic payments.
· You paid medical expenses totaling more than 7.5% of your adjusted gross income. You do not have to itemize your deductions on your income tax forms to qualify for this exemption, but you must be prepared to substantiate your claims-a properly legal way of saying “save all your bills or receipts.”
· You are subject to “a qualified domestic relations court order”-another very properly legal way of saying that a divorce decree or separation agreement instructs you to take a 401k early withdrawal in order to compensate your ex-spouse.
If you do not satisfy the criteria for a 401k early withdrawal without penalty and tax consequences, you will pay an extra 10% tax on the taxable amount of the withdrawal. And the whole 401k early withdrawal usually is taxable, often at the highest rate the law allows. In some exceptional circumstances you can avoid the penalty, but the 401k early withdrawal always will be added to your income for the year in which you take the distribution. The addition may bump you into a tax bracket which bears no resemblance to the reality of your financial life.
Given that your 401k probably numbers among your largest financial assets, the temptation to cash-it-out makes perfect sense, and some circumstances may render the 10% penalty and extra income taxes almost tolerable. Remember, though, that you have other ways to take money from your 401k without enduring the most painful consequences: Consider, for example, taking a loan from your account instead of requesting a 401k early withdrawal.
Most of all, as you begin weighing any of these options, speak with the 401k administrator at work-usually the payroll person or the Human Resources Specialist. And, then, definitely talk to your tax advisor or your financial planner. Do not make this decision without benefit of expert counsel, and do not make-up your mind too quickly.