Types of 401k Early Withdrawal

In 1980, the US government set up 401(k) plans to help workers save for their retirement. However, many applicants have taken 401k Early withdrawal to utilize this money before retirement, adverse to Congress' original intent. But Congress did realize that in some cases, these early 401k withdrawals were justified and as such, created a category called "401k hardship withdrawals." Opting to obtain funds from your organization's 401(k) plan can be difficult before attaining the official age of 59½ as an early 401k withdrawals must be very specific to qualify as a hardship withdrawal.

In order to take a 401(k) early withdrawal before retirement, have the withdrawal fit into one of these categories below.

401k Hardship Withdrawals

As stated in the paragraph above, Congress has specific conditions that qualify as hardships, thereby permitting an early 401k withdrawal without penalty. Before qualifying for a specific category of hardship, there are primary conditions to be met:

(1) the hardship withdrawal is due to an immediate and heavy financial need;
(2) the withdrawal must be necessary to satisfy that need because you have no other funds available;
(3) the withdrawal must not exceed the sum you need;
(4) you must have first obtained all distribution or nontaxable loans available under the 401k plan; and
(5) you can't contribute to the 401k plan for six months following the withdrawal.

Congress also left it to each employer whether they desired to include these hardship provisions in their 401k. So it is possible that your employer simply does not offer the hardship withdrawal provision in the 401k at your company. Even in available, one of the major downsides is that being eligible for any of the conditions can be hard. Just like the Congress has a list of qualifying financial hardships, such as health expenses and disability, individual plans as also have a list that can be more restrictive. What makes it more complicated is the fact that you have to meet the requirements under both sets of rules.

The other snafu encountered with a 401k hardship withdrawal before age 59 ½ is the 10% penalty on whatever you have withdrawn. Income tax would be enforced on the money you withdraw. The early 401k withdrawal can become costly. After deducting the federal and state income taxes, and paying the 10% early withdrawal penalty, you run the risk of ending up with mere $5000, after $10,000 401k early withdrawal.

401k Withdrawals That are Non-hardship

Every 401k plan does not permit a non-hardship withdrawal. There is a possibility for you to make a 401k early withdrawal and reallocate it according to your wishes, if your 401k plan allows you to do so. These non-hardship 401(k) withdrawals are most frequently referred to as in-service 401k distributions. To roll these funds into your IRA, plan members use this in-service provision, if it is available to them. Generally, with lower administrative fees and a wider variety of investment alternatives, many 401k participants eagerly use this provision to take control of their retirement dollars.

Loans

A 401k loan is not really an early 401k withdrawal as the money must be repaid. You are permitted to have a loan from 401(k) against your funds. While loans are a provision permitted by the government to be in a 401(k) plan, your company's plan may not allow loans. Loans cannot be rolled over into an IRA and have to be repaid, generally, within five years. Normally, you will be given short notice of one or two months to pay back the loan if you haven't repaid the 401k loan and left the firm. If you cannot pay it back, then the loan gets classified as a withdrawal, or 401k early withdrawal if under age 59 1/2, and taxes and penalties could apply.