401Ks are tax-advantaged retirement savings accounts, and many people contribute money to them every single year. Sometimes employers will match those contributions, creating the potential for you to build up a significant nest egg with a 401K.
Equally important as putting money into the account is knowing when the best time is to make withdrawals. If you take money out before a certain age, you will likely face income taxes and a 10% penalty. With a sound understanding of the rules and consequences around 401K withdrawals, you will be able to make better decisions when it comes to pulling out your hard-earned money, ultimately keeping more of it for yourself.
When Can You Withdraw from a 401K Without Penalty
Typically, if you withdraw from a 401K early, you will be subject to income taxes on the amount plus a 10% penalty. For most, that’s a large enough incentive to wait until the funds can be withdrawn penalty-free. The IRS allows penalty-free withdrawals from 401Ks after the age of 59 ½. You will either be still working or already retired, and the rules differ slightly in these two scenarios.
Still Working at 59 ½
If you remain employed at this age, you will be able to withdraw from your 401K at this point penalty-free. However, if you have recently changed jobs, you might not have equal access to the funds at your current employer.
Already Retired at 59 ½
If you retired after the age of 55, you are free to make penalty-free withdrawals from your 401K at 59 ½. Similarly, if you rolled your 401K over to an IRA account at some point, you can still withdraw penalty-free at 59 ½.
The Rule of 55
There are several exceptions to the suggested 59 ½ withdrawal age; the Rule of 55 is one. If you leave your job during the year you turn 55, you may be eligible to make early penalty-free withdrawals from that employer’s 401K plan. You should note that the funds you withdraw will still be subject to income taxes; the rule only applies to the funds at your most recent job. Additionally, your employer is not necessarily obligated to grant you these early distributions.
401K Withdrawal Requirements
The IRS mandates that Required Minimum Distributions (RMDs) are taken annually from your 401K account starting at the age of 72. The purpose of RMDs is to prevent people from using a retirement savings account as a prolonged income tax shield.
Each year the RMD is calculated, and if you have multiple retirement savings accounts, you must take the RMD for each. Typically, the plan administrator will calculate the RMD and report it to the IRS. There are also many online tools available for you to calculate the amount yourself. If you are still working at 72, some plans will allow you to defer the start of your RMDs until you decide to retire.
Best Way to Withdraw 401K
After you have worked so hard to stash money away for retirement, the last thing you want is to lose more of it than necessary to taxes. By starting to take smaller withdrawals before the age of 72, you will spread your tax bill out over more years, which could help you stay in a lower tax bracket. You also want to avoid taking two withdrawals in the same year, resulting in a higher tax bill.
Proactive planning is the best way to ensure you maximize the value of your 401K. Working with a professional financial planner offers expert advice catered to your personal goals. Creative Financial Group offers first-class financial advisory services, and we are pleased to assist with managing 401Ks and other retirement savings accounts.
This content was originally published here.