401(k) hardship withdrawals and loans
Your 401(k) plan may allow you to access your savings while you are still working. The two most common ways to do this are through a hardship withdrawal or a loan.
Hardship
A hardship withdrawal may be taken when the employee or business owner has an urgent financial need. Most plans allow withdrawals for the following types of financial hardships:
- Certain medical expenses
- Purchase of a principal residence
- Tuition and related educational fees
- Preventing eviction or foreclosure on principal residence
- Funeral expenses
- Repair of certain damages to a principal residence
Most plans require the employee to stop contributing to the plan for six months following a hardship distribution. Hardship distributions are taxable and subject to the 10% early withdrawal penalty unless an exception applies.
Loans
Most 401(k) plans allow the business owner and employees to take loans from their 401(k) balances. 401(k) loans are generally paid back to the plan account, with interest, through payroll deductions.
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Taking 401(k) distributions in retirement
The 401(k) withdrawal rules require you to begin depleting your 401(k) savings when you reach age 72.
At this point, you must take a “required minimum distribution” each year until your account is depleted. If you are still working for the employer beyond age 72, you may be able to delay required minimum distribution until you stop working if your plan allows this delay. The delay option is not available to you if you own 5% or more of the business.
You have until April 1 of the year after you turn 72 to take your first required minimum distribution. After that, you must take a minimum amount by December 31 each year. Your 401(k) plan administrator will tell you how much you are required to take each year.
The amount is based on your life expectancy and your account balance. If you don’t take your required minimum distribution each year, you will have to pay a tax of 50% of the amount that should have been taken but was not. If you participate in more than one employer plan, you must take a required minimum distribution from each plan.
I'm quite familiar with the concepts surrounding 401(k) plans, hardship withdrawals, loans, and the intricacies of required minimum distributions (RMDs). To substantiate my expertise, let's delve into the core components of these financial tools:
401(k) Plans: These are retirement savings accounts offered by employers, allowing employees to contribute a portion of their pre-tax salary. The funds grow tax-deferred until withdrawal during retirement.
Hardship Withdrawals: These are distributions made from a 401(k) plan due to specific financial hardships like medical expenses, purchasing a primary residence, education fees, eviction or foreclosure prevention, funeral expenses, or certain damages to a primary residence. They're subject to taxation and a 10% early withdrawal penalty unless exceptions apply. Typically, contributions to the plan cease for six months post a hardship distribution.
Loans from 401(k): Many plans permit individuals (including business owners and employees) to borrow from their 401(k) balances. These loans are repaid to the plan account, usually with interest, via payroll deductions.
Required Minimum Distributions (RMDs): Once an individual reaches age 72, the IRS mandates a minimum withdrawal amount annually from their 401(k) to ensure taxation on these retirement funds. The RMD amount is determined based on the account balance and life expectancy. If an individual fails to withdraw the RMD, they face a hefty tax penalty of 50% on the amount that should have been withdrawn but wasn't.
Regarding the age 72 requirement, individuals must start taking RMDs by April 1st of the year following turning 72 and subsequently by December 31st each year. However, if still employed after 72, individuals might defer RMDs until retirement, provided their plan allows this delay. Notably, this deferral isn't an option for individuals owning 5% or more of the business.
Should an individual participate in multiple employer plans, they're obligated to take RMDs from each plan separately.
Understanding these facets can profoundly impact retirement planning, tax obligations, and financial well-being in later years.
