What options will minimize penalties and taxes when taking out my 401(k) from my previous employer?
I have a 401(k) plan with my employer that I just recently resigned from. I need to take a portion of the amount out and would like to invest the rest. I'm under 40 years old and I worked for the company for 20 years.
When withdrawing funds from a 401(k), you will be subject to ordinary income taxes as well as a 10% penalty for withdrawing before the age of 59 1/2. If you withdraw only a portion, that portion will still be subject to ordinary income taxes and the 10% penalty. To avoid the taxes and penalty completely, you will need to reinvest the assets from the 401(k) into a Rollover IRA. You must do so within 60 days after the date of the withdrawal.
If you mean to ask what are the exceptions to early withdrawal i.e. before you reach the age of 59.5 years (after which you can withdraw without any penalties.) According to the IRS the following exceptions are available among others: Death, disability, divorce, medical expenses over 10%, separation from service at or after 55 years of age and if you elect to receive a series of substantially equal payments. The IRS has a nice table on its website with the exceptions (See link below)
The above exceptions are for the 10% penalty on early withdrawal. You will still have to pay the taxes on withdrawal. You can minimize taxes if your overall taxable income in the year of withdrawal is low (For example between jobs).
I would echo the sentiment of the other advisers, that withdrawal from your 401K should be your last resort.
As for a rollover of a 401K to another retirement account such as your new employer's 401K (If the plan allows it) or an IRA account, then you would not pay any penalty or taxes if the rollover takes place within 60 days. A trustee to trustee transfer/rollover (Explained by the others in response to your question) would be your best option.
First and foremost, I would look at any other ways you can get the money that you need. Taking distributions at your age will probably cost you about 30-40% in taxes and penalties. If you still want to withdraw from your retirement funds, here's what I would do:
1) Roll over the funds into an IRA. The rollover is not a taxable event.
2) Take a portion of the money you need in 2017 and the rest in 2018. This way you might be able to avoid getting pushed into a higher tax bracket.
I hope this helps.
Generally, I would recommend looking to your retirement funds for something other than retirement, only as a last resort. However, understandably, there are circumstances when this is the option you are left with.
Assuming it is a pre-tax 401k, the amount you take out will be counted as ordinary income, and subject to income tax. To minimize this, or reduce the risk of being bumped into the next tax bracket, you could divide the amount you need and take some in 2017 and the rest in 2018, if possible.
If you roll the money into an IRA, there are certain circumstances under which you can take early withdrawals without the 10% penalty. These include qualified education expenses (for you, your spouse, your children, or your grandchildren), to purchase a home (if you are a first-time home buyer), or if you become disabled.
First you want to rollover the assets DIRECTLY to an IRA. From there you can invest whatever portion you like and take a distribution(s) for what you need. If you are over 59 1/2, there will not be a 10% penalty, but under 59 1/2 there is a 10% penalty. Now there are a few "qualifying" exceptions to the 10% penalty like unreimbursed medical expenses, higher education, medical insurance, etc.. but they must qualify & be done correctly. Any distributions will be added to your taxable income & you will have taxes to pay on that income.
But you could spread the distributions out over 2 years to better control & defer some of your taxes. Thus you could take out a portion before Dec 31st of this year, and then again in Jan of 2018. This will defer the portion taken out next Jan and may even keep you in a lower tax bracket.
The reason you want to roll the assets into an IRA first before making any distributions is that a 401k is required to withhold 20% of the distribution & send to the IRS even if your tax rate is lower. With the IRA, you can set your own withholding rate - 0%, 8%, 15%, etc... - based upon your goals
Now you just need to come up with a good investment strategy for the assets remaining inside the IRA.
Hope this helps and best of luck, Dan Stewart CFA®