The financial crisis has taken a heavy toll on the personal finances of most people. A natural reaction is to consider withdrawing funds from a tax advantaged saving plan such as a 401k or IRA.
The reality, though, is that funds from such sources can be extraordinarily expensive when all of the penalty fees and tax implications are taken into account.
The rules are complex and generally depend on a person's age and the type of plan involved. Some high-level points to consider:
- The federal government imposes a 10% early withdrawal penalty for 401k or traditional IRA withdrawals before age 59.5.
- These early withdrawals are also subject to federal, state and local income taxes during the year the withdrawal is made.
- Withdrawals from an employer sponsored 401k before age 59.5 are generally not permitted. That said, "hardship withdrawals" (avoiding foreclosure, funeral expenses, medical expenses, etc) are allowed but are still subject to income tax.
- Individuals under age 59.5 can take loans from their 401k plan. The amount of the loan cannot exceed 50% of the account value or $50,000. The loan must be paid back within 5 years unless it is for a home loan, and the interest paid on the loan goes into the participant's account. If you lose your job, however, the loan is typically required to be paid within 60 days.
- Individuals who lose a job between age 55 and 59.5 can withdraw funds from a former employer's 401k plan without penalty.
- Section 72(t) payments allow for "substantially equal periodic payments from an IRA or former employer's 401k. The withdrawals can be made without penalty but are subject to income tax.
- Individuals can take withdrawals from an IRA after reaching age 59.5, but the withdrawals are subject to income tax.
- Some 401k plans allow participants over age 59.5 to take "in service" withdrawals.
Source: Wall Street Journal (subscription required)
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