Sometimes, life isn’t predictable. You expected to stay in your job forever, but were recently the victim of a downsizing. You know that you’re able to take an early withdrawal from your 401(k), and you’re not even that bothered by the fact that you’ll have to pay a penalty to do so. After all, this is an emergency situation.
You can always Leave the money in your former employer's plan; Roll over the money to your new employer's plan, if the plan accepts transfers; Roll over the money into an Individual Retirement Account (IRA); or Take the cash value of your account.
Before you start taking money out of your retirement fund, however, think twice. Not only will you have to pay a penalty if you’re below the qualifying age, but that money won’t be growing in your retirement fund. Here are a few different things to consider before taking money out of your 401(k).
Save for Emergencies
Hindsight is always 20/20, but if you start saving for an emergency now, you may not have to turn to your 401(k) as a source of money. Having a two to three month emergency fund in your savings account is a great idea, and one that many Americans don’t take full advantage of. Sure, that money may not be growing toward your retirement, but dipping into it is much less detrimental.
Roll the IRA or Move it Into a New Plan
If you can save for your emergency and make it until you have a new job, see if you can move your old 401(k) into your new employer’s plan or roll it into an IRA.
The idea here is that you want to keep your 401(k) intact so that you can maximize your retirement savings and preserve your ability to get a loan…
Consider a Loan Instead
If you feel that you do need to dive into your 401(k), consider getting a loan from it instead. There are no taxes or penalties on a loan and repaying the loan reinvests into your retirement. Additionally, the interest you pay is paid back onto your own account so you only lost earnings that you would have received on the money you borrowed.
If you do not transfer your money to an IRA or your new employer's plan within 60 days of receiving it, your current employer is required to withhold 20 percent of your account balance to prepay federal taxes. The IRS has introduced a self-certification procedure if you inadvertently miss the 60-day time limit.
If you keep the money, you must pay federal income tax on your entire withdrawal. In addition, you may also owe state tax on your distribution.
Plus, the IRS will consider your payout an early distribution, meaning you could owe a 10 percent early withdrawal penalty on top of combined federal, state, and local taxes.
If you’re in a position where you feel that you may be considering tapping into your 401(k) before its time, please be sure to reach out to Steel Valley Investment Group of Raymond James.
Changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of Raymond James & Associates we are not qualified to render advice on tax or legal matters.
Opinions expressed are not necessarily those of Raymond James & Associates. Information contained was received from sources believed to be reliable, but accuracy is not guaranteed. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. Past performance may not be indicative of future results.