The cost of cashing out retirement plans early | Equitable (2024)

FAQs

The cost of cashing out retirement plans early | Equitable? ›

If you take the money as a plan distribution before age 59½, you'll owe the IRS a 10% early withdrawal penalty. You'll also owe ordinary income tax in the year you receive the distribution.

What is the 401(k) early withdrawal penalty? If you withdraw money from your 401(k) before you're 59 ½, the IRS usually assesses a 10% tax as an early distribution penalty. That could mean giving the government $1,000, or 10% of a $10,000 withdrawal, in addition to paying ordinary income tax on that money.

Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called "early" or "premature" distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies.

Withdrawing money early from your 401(k)—that is, before you turn 59½—comes fraught with financial risks. It's universally considered a bad idea to prematurely siphon funds from a nest egg that can help support your lifestyle in retirement or protect you in your senior years from the high cost of healthcare.

The IRS dictates that investors must be totally and permanently disabled before they can dip into their retirement plans without paying a 10 percent penalty. Rothstein says the easiest way to prove disability to the IRS is by collecting disability payments from an insurance company or from Social Security.

You can withdraw your contributions (that's the original money you put into the account) tax- and penalty-free. But you'll owe ordinary income tax and a 10% penalty if you withdraw earnings (i.e. gains and dividends your investments made inside the account) from your Roth 401(k) prior to age 59 1/2.

The money in a 401k grows tax-free until it is withdrawn, usually after retirement. However, if you withdraw money from your 401k, a traditional or a Roth 401k, before you turn 59-and-a-half years old, you incur a 10 percent early withdrawal penalty.

Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.

If your career is winding down and you find yourself earning less income, it may be necessary to take distributions from your retirement plan. If you're at least 59 ½ years old, you'll be able to take distributions from retirement plans without getting hit with a 10 percent early withdrawal penalty.

Most Americans retire in their mid-60s, and the Internal Revenue Service (IRS) allows you to begin taking distributions from your 401(k) without a 10% early withdrawal penalty as soon as you are 59½ years old. 1 But you still have to pay taxes on your withdrawals.

Should I cash out my IRA to pay off debt? ›

Debt payoff may seem like a good use of IRA funds now, but it can jeopardize your retirement savings and put you in a worse financial state later. You need to let the funds grow over time, and reducing the balance now could seriously impair your savings potential in the future.

Say an investor has retired with a $1 million portfolio. In her first year of retirement, under the 4% rule, she should withdraw 4% of that portfolio, or $40,000 ($1 million x 0.04). For each subsequent year, she should adjust the withdrawal amount for inflation.

The short answer: It depends. If debt causes daily stress, you may consider drastic debt payoff plans. Knowing that early withdrawal from your 401(k) could cost you in extra taxes and fees, it's important to assess your financial situation and run some calculations first.

Generally, early withdrawal from an Individual Retirement Account (IRA) prior to age 59½ is subject to being included in gross income plus a 10 percent additional tax penalty. There are exceptions to the 10 percent penalty, such as using IRA funds to pay your medical insurance premium after a job loss.

The IRS dictates you can withdraw funds from your 401(k) account without penalty only after you reach age 59½, become permanently disabled, or are otherwise unable to work.

You can withdraw money from your IRA at any time. However, a 10% additional tax generally applies if you withdraw IRA or retirement plan assets before you reach age 59½, unless you qualify for another exception to the tax.

The 4% rule is when you withdraw 4% of your retirement savings in your first year of retirement. In subsequent years, tack on an additional 2% to adjust for inflation. For example, if you have $1 million saved under this strategy, you would withdraw $40,000 during your first year in retirement.

By age 59.5 (and in some cases, age 55), you will be eligible to begin withdrawing money from your 401(k) without having to pay a penalty tax. You'll simply need to contact your plan administrator or log into your account online and request a withdrawal.

In general, Roth 401(k) withdrawals are not taxable, provided the account was opened at least five years ago and the account owner is age 59½ or older.