401K Withdrawal Rules – Why Is It Better To Leave Plan Alone?

401K Withdrawal Rules

Employers generally administer and provide 401K plans for their employees. Workers normally contribute their own money into the 401Ks to provide for retirement and matching funds are contributed by employers at a predetermined amount of the employee’s income.401K rules can be confusing, but it is important for employees to understand how to obtain the best return on their investments. Essential 401K withdrawal rules to be familiar with are the contribution rates, withdrawal penalties, 401K rollovers and loans against the fund. There are tax implications that need to be adhered to when organizing and administering a 401k retirement plan.

Contributions to a 401K plan can be voluntary or set up as a percentage contribution set by the employer. At times the employer may require employees to contribute as low as 2% to their retirement funds for early retirement planning, or the plan may have no contribution requirements.

A 401K withdrawal penalty can be waived if specific requirements are met. The IRS requires that an extreme hardship withdrawal can qualify for penalty waivers or if the employee is 59 ½. Funds can be withdrawn at the end of employment or termination of the plan, but it is advisable to roll over 401K funds into another approved plan. Distributions with or without penalty can be taken in a lump sum or in installments. 401K withdrawal rules require that plan participant begin taking distributions from their 401K at the age of 70 ½ or on retirement.

Loans against a 401K account can be allowed in cases of extreme financial hardship where there is no other source of borrowing. This can be for college tuition, using 401K to buy a house, or extreme medical conditions. There is no judgment call made by the employer in regards to hardship withdrawals, the written word of the employee is usually all that is required for documentation.

401K withdrawal rules set up by the IRS include a 10 percent penalty for early withdrawals. This rule is designed to penalize those who take out retirement funds before the age of 59 ½ and use the money frivolously. Unfortunately the 10% penalty for early withdrawal is in addition to any taxes you are required to pay on your retirement withdrawal. The amount you take from your 401K plan needs to be reported on your income taxes and this includes the 10% penalty. You will add the withdrawal amount as income and be taxed at the proper rate. This can add up to very high taxes and you will essentially lose the benefit of your 401K. 401K withdrawal rules states that the IRS does not tax rollovers or loans and these distributions are not subject to the 10% rule. However if you have a loan against a 401K account and your employment is terminated or you quit; pay the loan back quickly or it will be treated as a distribution, taxed, and subtracted from your 401K funds.

Retirement savings statistics including 401K plans for the typical 45 year old American indicate a retirement savings of $18,750. Those 55 and older have only $60,000 in retirement savings, and baby boomers have an average 401K account balance of $80,000. One in five of workers aged 55 ignore 401K withdrawal rules and withdraw retirement funds to help with debt payments, investments in other financial portfolios, and indiscriminate spending. This adds up to little security on retirement.