A 401(k) is a retirement plan, and as such it comes with certain rules that owners of the account and employers must follow. While it is possible to access 401(k) funds under certain circumstances, the IRS has very specific restrictions, and the companies sponsoring these plans may add rules that put additional limits on what you can do with the money.
There are several requirements you must meet before withdrawing from your 401k, although this is money you have set aside for retirement, there is no guarantee you can get access to this money before your retirement.
The Basics of 401(k) Withdrawals
The IRS mandates that you leave your money in your 401(k) until you reach the minimum retirement age of 59 1/2, become permanently disabled, have a specific financial hardship, the plan dissolves or you leave your job. If you meet any of these conditions, you may be able to take funds from your 401(k), but the amount may be limited and in some cases, you can still be refused. It’s also important to be aware that you may or may not be eligible for any additional funds that the company has contributed to your account, depending on the details of your plan and how long you have participated in it.
Income Tax and Penalties
If you do not meet age or hardship requirements, funds withdrawn from a 401(k) plan are typically subject to both income tax and penalty withholding. The amount held back for taxes is 20 percent of the withdrawal amount. You might also be subject to having an additional 10 percent held back to cover the cost of IRS penalties on early withdrawals, though in some cases this may not apply. Withdrawal amounts from 401(k) accounts are added to your total income for the year, possibly resulting in a tax liability that exceeds the amount of the withholding.
Withdrawing at Retirement
Once you have reached retirement age, you may begin to withdraw funds from your 401(k) without incurring any penalties. At this point, your employer or fund manager cannot refuse to give you the money in your fund, either as a lump sum distribution or as equal periodic payments. You're liable for income taxes on this money, and if you're still working, it might be better to wait to take money from your 401(k) until after you retire to avoid ending up in a higher tax bracket.
Hardship Withdrawal Requirements
The IRS allows you to withdraw money from your 401(k) without penalty for any of a number of different hardship situations. Hardships include medical bills, funeral expenses, college expenses or health insurance premiums if you are out of work. You can also take up to $10,000 for the purchase of your first home. Check your 401(k) documents carefully, because even though the IRS allows such withdrawals without penalty, not all plans will let you take money from your plan for hardships.
Loans Against 401(k)s
A better option may be to take out a loan against your 401(k). You'll pay interest, but the interest you pay goes back into your plan, making it a win. However, you will lose the interest you would have earned on that money had you left it in the plan. This is another area where your request can be denied, however, since employers aren't required to allow loans when they set up their 401(k) plans. According to the Employee Benefit Research Institute, though, about half of all employers allow employee loans. If your employer allows it, you'll be limited to $10,000 or 50 percent of your vested balance, whichever is greatest, or $50,000 if your plan has $100,000 or more in it. You'll be required to make equal loan repayments at least once every quarter, so be prepared to repay if you choose this option.