A 401(k) plan is a profit-sharing plan designed to allow employees to defer salary for retirement savings. There are some considerations you should be aware of when determining if and how you make withdrawals from your 401(k) plan, including how provisions in the CARES (Coronavirus Aid, Relief, and Economic Security) Act legislation could impact your withdrawal decisions.
Tax on 401k Distribution
Distributions from a 401(k) are taxed as ordinary income. Ordinary income is taxed at a progressive rate, meaning income is taxed in layers with a higher tax rate applied to each layer.
401k withdrawal early penalty
A 10% 401(k) early withdrawal penalty may be incurred when the withdrawal is made before the age of 59-1/2.
11 reasons you can withdraw from 401k without a penalty include
- Attainment of age 59-1/2 which generally requires a triggering event – be sure to check with your 401(k) plan administrator.
- If you are under the age of 59-1/2 and are separated from service in or after the calendar year in which you turn 55, you will not incur the 401(k) withdrawal penalty.
- A hardship withdrawal is a distribution from a retirement or 401(k) plan to account for an immediate and heavy financial need of the employee. 401(k) plans may, but are not required to, offer hardship withdrawals. The withdrawal must be necessary to satisfy the financial need.
- A disability as defined by the IRS
- The death of the participant
- A systematic withdrawal, however, this is rarely allowed by a qualified plan.
- If there are distributions to an alternate payee under a Qualified Domestic Relations Order (QDRO) - generally due to divorce.
- An IRS tax levy
- A Qualified Reservist Distribution
- If distributions are made to an employee for medical care up to the amount allowable as a medical expense deduction. See IRS Publication 560 or consult a tax professional for details.
- For a qualified birth or adoption participants can withdraw up to $5,000 per parent ($10,000 aggregate) without penalty within one year of the birth or adoption.
The CARES Act and 401k withdrawal
The CARES Act was signed into law in 2020 to help provide financial stability and relief for individuals and businesses affected by COVID-19. As a result, it has implications on making 401(k) withdrawals. Under the CARES Act, early 401(k) withdrawal penalties are eliminated for qualified individuals making withdrawals up to $100,000 for coronavirus related distributions.
While the CARES Act eliminates early 401(k) withdrawal penalties, income tax on the distributions of pre-tax assets would still be owed but could be paid over a three-year period. Individuals could "recontribute" the funds to a retirement account within three years without regard to contribution limits.
Can I still withdraw from my 401k without penalty in 2021?
You can still make a withdraw from your 401(k) plan in 2021; however, the penalty exemptions offered by the CARES Act ended on December 31, 2020. Therefore, the penalty exemptions listed above still apply for 2021.
How to withdraw 401k money
As with any decision involving taxes, consult with your tax professional on considerations and impacts to your specific situation. An Edward Jones financial advisor can partner with them to provide additional financial information that can help in the decision-making process. When considering withdrawing money from your 401(k) plan, you can withdraw in a lump sum, roll it over or purchase an annuity. Your financial advisor or 401(k) plan administrator can help you with this.
Work with your Financial Advisor and tax professional
Together with your financial advisor, you can discuss how the above items may affect your current situation and your long-term financial goals. If you do not currently work with a financial advisor, we invite you to meet with one of our qualified financial advisors today.