How much is the penalty for withdrawing the 401K?

Before you start your 401K retirement plan, you should know that it will be much easier to put your money into it than to take it out, unless you have reached the age of 59½. If you try to make an early withdrawal and don’t proceed cautiously, you could have to pay too high a price. Let’s see how much is the penalty for withdrawing the 401K.

How much is the penalty for withdrawing the 401K?

The penalty or penalty for withdrawing the 401K before turning 59½ is 10%. However, this is not the only difficulty you will face when making your early withdrawal, continue reading.

Three Consequences of an Early Withdrawal from a 401(k) or Cashing Out a 401(k)

1. Taxes will be withheld

The I.R.S. usually requires the 20% automatic withholding of a 401(k) early withdrawal for taxes. So if you withdraw $10,000 from your 401(k) at age 40, you may get only about $8,000. Note that you may be able to recover a portion as a tax refund at the time of your return if the withholding exceeds your actual tax liability.

2. Penalty or fine for withdrawing the 401k

If you withdraw money from your 401(k) before age 59½, the IRS will normally apply a 10% penalty when you file your tax return. That could mean giving the government $1,000 of that $10,000 withdrawal. Between the taxes and the fine, the total you take home could be as little as $7,000 of the $10,000 withdrawn.

3. You would have less money in the future

That may be especially true if the market is trending down when you make the early withdrawal. “If you’re withdrawing funds, you can severely affect your ability to participate in a rebound where your entire retirement plan would be offset,” says Adam Harding, a certified financial planner in Scottsdale, Arizona.

Keep reading: Withdraw the 401 (k) without penalty for Coronavirus, is it possible?

How long will it take to collect a 401(k) after you leave your job?

Depending on who manages your 401(k) account (a brokerage, bank, or other financial institution), you may have to wait 3-10 business days to receive your check after your 401(k) is cashed.

Still thinking about cashing in your 401(k) or taking an early 401(k) withdrawal?

1. See if you qualify for an exception to the 10% tax penalty

Generally, the IRS will waive the penalty in these situations:

  • You choose to receive periodic “equal” payments. Basically, you agree to receive a series of equal payments (at least one per year) from your account. They start after you stop working and continue for life (be they yours or your beneficiary’s). Generally, they have to stay the same for at least five years or until you turn 59½. Many rules apply to this option, so be sure to consult with a qualified financial advisor first.
  • you quit your job. This works only if it occurs in the year you turn 55 or older (50 if you work in federal law enforcement, federal firefighting, customs, border protection, or air traffic control ).
  • You have to split a 401(k) in a divorce. If the court’s qualified domestic relations order in your divorce requires collecting a 401(k) to split with your ex, withdrawing to do so may be penalty-free.

There are other exceptions with which you would not pay the 10% fine If you are cashing in a 401(k) or taking an early withdrawal from the 401(k):

  • You become or are disabled.
  • You have transferred the account to another retirement plan (within a certain time).
  • Payments were made to your beneficiary or his estate after his death.
  • You gave birth to a child or adopted a child during that year (up to $5,000 per account).
  • The money paid an IRS lien.
  • You were the victim of a disaster for which the IRS granted relief.
  • You overcontributed or were automatically enrolled in a 401(k) and want to get out (within certain time limits).
  • You were a military reservist called to active duty.

2. Check if you qualify for a hardship withdrawal

The IRS defines this situation as “an immediate and heavy financial need”. Generally includes:

  • Medical bills for you, your spouse, or your dependents.
  • Money to buy a house (but not to make mortgage payments).
  • College tuition, fees, room and board for you, your spouse, or your dependents.
  • Money to avoid foreclosure or eviction.
  • Funeral expenses.
  • Certain expenses to repair damage to your home.

Your employer’s plan administrator usually decides if you qualify. You may have to explain why you can’t get the money elsewhere.

Generally, you can withdraw your 401(k) contributions and perhaps any matching contributions made by your employer, but usually not the earnings on the contributions. Check your plan, you may have to pay income taxes on a hardship withdrawal and you may also be subject to the 10% penalty mentioned above.

3. Consider converting your 401(k) to an IRA

Individual retirement accounts have slightly different withdrawal rules than 401(k)s. Therefore, You may be able to avoid the 10% penalty for early 401k withdrawals by converting your 401(k) to an IRA first.. Before you begin, make sure you understand the investment and fee differences between 401(k)s and IRAs. For example:

  • There is no mandatory withholding on IRA withdrawals.. That means you can choose not to have tax withheld and get a larger check now. However, you have to pay the tax when you file your return. If you’re in dire straits, rolling over the money into an IRA and then withdrawing the full amount could be a way to get a 100% distribution. This strategy is good for people who pay low taxes or who know they are getting refunds.
  • You can withdraw up to $10,000 for the purchase of your first home. If you find yourself in this situation, rolling over a 401(k) to an IRA can be a great way to make a withdrawal without paying the 10% penalty.
  • Tuition fees may qualify. You can withdraw the expenses of the college as long as they meet the IRS definition of “qualified higher education expenses.”

4. Take the minimum when you collect a 401(k)

When you make early withdrawals from your 401(k), you will have two immediate costs (taxes and/or penalties) which will be very well defined based on your age and tax rates. As well as the investment experience you could have enjoyed if your funds remained invested in the 401(k). Therefore, you must take into account and analyze this total cost before making early withdrawals.

conclusion

Never take an early withdrawal from a 401(k) for things like paying down debt or buying a car; you should only consider them for emergencies. Even if you manage to avoid the 10% penalty, you’ll probably still have to pay income taxes when you collect your 401(k). In addition, you could harm your retirement.

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