If you need to take money out of your 401(k) plan before retirement, there are three ways to accomplish that. The first way is to take out a 401(k) loan. But 401(k) loans are not always the best way to borrow money. Interest paid on a 401(k) loan is generally not tax-deductible. To figure out your best option, calculate the true cost of borrowing in each case.
Second, most 401(k) plans will allow you to take a hardship withdrawal. Make sure you look at all your available options before taking a 401(k) loan or a hardship withdrawal. Finally, if you are over age 59½ or meet other exceptions to the 10% early withdrawal penalty, you can withdraw your 401(k) money without penalty. You will have to pay ordinary income tax on the amounts received. See the section Your 401(k) When Switching Jobs.
Thanks to the CARES Act passed by Congress in March 2020, there are several temporary changes to the rules for 401(k) accounts that can mean a withdrawal makes more sense than usual. But in order to qualify under these new rules, you’ll need to certify that you’ve been financially affected by the coronavirus pandemic.
First, you must have been diagnosed with coronavirus, had a spouse or dependent diagnosed with it, been laid off, furloughed, quarantined, or your hours have been reduced, and as a result have suffered adverse financial consequences. Others that qualify are those who have had to stay at home to take care of children because you have not had access to daycare, and business owners that were shut down due to the pandemic.
Also, your 401(k)’s plan sponsor — meaning your employer, or former employer if it’s an old account — needs to adopt the new CARES Act rules, and they’re not required to do so. Check with your HR department or the firm that administers your plan to find out if it’s eligible for a coronavirus-related distribution.
But if both you and your plan are eligible, the normal 10% penalty for making a 401(k) withdrawal before you turn 59½ years old is currently waived on distributions of up to $100,000. That’s a major roadblock that normally dissuades people from using their retirement savings early, and it’s been eliminated for the rest of 2020.
The mandatory 20% federal tax withholding on any early withdrawals you make from a 401(k) account has also been waived for the rest of the calendar year. But be careful on this one. Even though your plan won’t take taxes out of your distribution, you still owe taxes on the money.
IMPORTANT NOTE: We generally recommend that you do not withdraw money from your 401(k). Explore all other alternatives first.
SUGGESTION: Penalty-free withdrawals can be made from an IRA for qualified higher education expenses.
SUGGESTION: A penalty-free withdrawal from an IRA up to a $10,000 lifetime limit can be made for a qualified first-time home purchase.
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