When can I take money out of my 401(k)?

A 401k is a tax deferred retirement savings account which allows an individual to save for retirement on a pre-tax basis.  Not only are the contributions tax free, but as the account balance grows, the interest income is also tax free.  The 401k balance is not taxed until the owner of the account begins to withdraw funds, which in theory will be in retirement when the owner’s tax level is much less.  Most 401k plans are employer sponsored and to further encourage their employees to save for retirement, many employers offer their employees a 401k match.  This match is normally between 2% and 5% of the employee’s income.

Technically, someone can begin withdrawing from their 401k at any age.  However, since 401k plans come with significant tax benefits and are designed to help save for retirement, early withdrawal, which is any withdrawal prior to being 59 and a half years old, often comes with a severe penalty.

One significant penalty is imposed by the employer who provides the 401k benefit to their employees.  To discourage their employees from withdrawing funds early many employers charge a 10% fee for all premature withdrawals.  However, many employers allow hardship withdrawals that are penalty free.  Examples of hardship withdrawals include death of the employee, excessive medical expenses, or temporary or permanent disability.

While they do not want their employees withdrawing from their 401k, many employers do provide their employees with the option to take out a loan against their 401k without penalty.  The loan can be used for just about anything, but is often capped at a certain dollar amount or 50% of someone’s vested balance.  This loan normally comes with a low interest rate and requires repayment over a few years.  If the loan is not repaid, then the employer will charge the 10% fee.

Another penalty of withdrawing from a 401k prior to turning 59 and a half years old are income taxes.  When someone withdraws funds from their 401k, they will have to pay taxes on the amount they withdraw.  The withdrawal will be taxed at the same levels as someone’s highest marginal tax bracket.  For most people, withdrawing funds earlier than 59 and a half is disadvantageous because their tax bracket is bound to decrease after entering retirement.  In most situations, when a 401k withdrawal takes place, the 401k servicer will hold back a certain portion of the funds which will be paid to the IRS when the account owner files their taxes.

Once a person reaches 59 and a half years of age, they can begin to withdraw from their 401k penalty free.  However, it is highly advised that 401k distributions not be taken until the account owner has stopped working and their tax level decreases.

Once an individual reaches 70 and a half years of age, they are required to start making minimal distributions from their 401k.  The minimum distribution is different for every individual and is based on current life expectancy tables that are held by the IRS.  If the 401k account owner fails to withdraw the required amount, the IRS will charge a very high fee of 50% of the required distribution.  However, the required distribution law does not apply to individuals who are still working.

Contributing to your 401(k)

A 401K is a popular savings plan that accumulates money towards retirement. Most consider a 401K to be a straightforward way to save for retirement, and it is ideal for individuals who do not want to make risky investments. These long term plans are generally available only through an employer. The employee must indicate how much money should be taken out of his paycheck; the money then gets invested in funds that accumulate value over time such as index based stock funds, growth funds, and money market funds. Generally, an employee can contribute no more than $16,000 annually to this fund.

401K plans, like any other financial plans, can face risks should they be put into risky investments; additionally, the Pension Benefit Corporation does not protect these funds. However, many choose to utilize the 401K because the employers often agree to match employee contributions. Should an employee contribute 5% of his salary every month to the plan, an employer may do the same, thus doubling the amount. 401K plans are also easy to understand and partake in and a person can choose different investment options, including those that are either safe or risky. Participants may also change both the percentage of their contributing salary but also the investments that the money is allocated.

Employees may also borrow money from their 401K plan. There are no restrictions with this money and these loans will not appear on credit reports; however, the employee may have to pay charges and fees, not to mention his losing the employer matching contributions when paying the loan.

Solo 401K
A Solo 401K is a retirement plan for business owners who are not only the sole owners of business but also do not have any staff presently. Employers who anticipate hiring staff in the future are also not eligible for the Solo 401K Plan. Should he have $100,000 in the plan, he can apply for a $50,000 loan. The employer may also deduct the Solo 401K contributions from his taxes. The tax savings are substantial as the Solo 401K investment will build on a tax-deferrable basis. One can contribute up to $40,000 a year and, beginning at age 50, an employer can also contribute a $2000 catch-up contribution.

This is a relatively new retirement plan and not offered by many financial establishments. Businesses that offer the service have annual maintenance fees and a one-time fee for setting up the account. There will be other charges if the financial business handles the employer’s accounts and bookkeeping as well. Additionally, a trustee is designated to hold the employer’s assets, though with careful planning it is possible for an individual to act as his own trustee. This requires meticulous planning with rules and guidelines clearly explaining how the plan will work.

401K Contribution Limits
401K contribution limits are set by an employer and the government. They determine how much the employee will contribute to his retirement plan. While these limits do not limit how much can be contributed, they limit some of the benefits such as tax deferments and employee contributions.