I have just been laid off. Can I use my 401(k) for living expenses now and report it as income next year?
No and yes.
No. You can't if you withdraw 401k money directly. If withdrawn this year from your 401K it must be reported as income this year.
Yes. You can use a work around that may work for you (see the caveat below). You can instead take a 401K loan this year - a loan is not income. If you need to withdraw it next year, you can stop making payments to your 401K loan in the New Year and it automatically becomes a distribution from your 401K and therefore taxable next year.
CAVEAT: If the 401K is held by the employer that laid you off (this is highly likely) you will not have access to their 401K loan plan. There is a workaround but you will need to work with an advisor that is knowledgeable on individual-401K plans (sometimes also called solo plans). Before you go through this effort make sure that you know the limits - the loan is limited to 50% of your total 401K to a maximum of $50K.
This is not recommended since you are using your future retirement assets to support a current need BUT it has helped some clients bridge their finances until they develop their own business or land a new position.
Any amounts withdrawn from your 401(k) plan must be treated as ordinary income for the year the amount is distributed from your 401(k) account. Consider the following:
- If any portion of the withdrawal is rollover eligible, the plan administrator must withhold 20% for federal taxes if the amount is paid to you instead of being processed as a direct rollover. State tax withholding may also apply.
- If you want to avoid the mandatory federal (and if applicable, state) tax withholding, you should have the amount processed as a direct rollover to a Traditional IRA and then take the distribution from the traditional IRA where you can waive withholding. However, you may want to check with your tax professional for assistance with determining whether you should have taxes withheld to satisfy any requirements for paying estimated taxes.
- As you may already know, withdrawing from your retirement plan should be a last resort, as you not only reduce the amount in your nest egg, but you also lose the benefit of having the amounts continue to accrue earnings on a tax-deferred basis. The impact can be quite significant and could put you behind with your retirement program.
- If you have no option but to withdraw amounts from your retirement account, you can roll over the amount within 60 days of receiving the check.
- You may be eligible for unemployment insurance in your state. See the Department of Labor's website for details. This could provide sufficient income until you find another job and negate the need to tap into your 401(k) plan.
You may want to talk to a retirement/financial counselor for some additional financial guidance.
This question was answered by Denise Appleby