Will I be exempt from the early distribution penalty if I rollover my 401(k) to an IRA within 60 days and take out distributions?
I'm 57 years old. If I retire and rollover my 401(k) to an IRA within 60-days of separating from my company (where I have the 401(k)), will I be exempt from the 10% early distribution penalty in the IRA if I take distributions out of the IRA before 59 1/2? I've heard conflicting stories on if the 401(k) is rolled over within 60 days of separating, whether an IRA is then also exempt from the 10% early tax penalty just like a 401(k) would have been.
Both a 401(k) and IRA are subject to an early withdrawal penalty before the age of 59 1/2. The IRS has a list of exemption that may qualify you for a penalty waiver. If you meet any of these conditions, you can withdraw you 401(k) / IRA funds without penalty.
Also, keep in mind that you will have to pay taxes on the entire withdrawal amount which will be added to all other earned income during the same tax year and taxed as an ordinary income. Depending on the exact amounts, you can potentially go to a higher tax bracket. There is some tax saving benefit if you consider annual distributions over a lump-sum withdrawal.
If you roll the 401(k) to an IRA before age 59 1/2, you will lose the loophole that allows you to take money out and avoid the penalty for early withdrawal. I recommend you stay in the 401(k) unless you have plenty of non-retirement money elsewhere to bridge the income gap until age 59 1/2.
Do not rollover a penny into an IRA until you check with your HR Specialist at work! Most 401(k)s allow for "early" penalty free withdrawals from their 401(k)s starting at age 55. So, while taking distributions before age 59 1/2, it might very well be (hugely) more advantageous to leave your money in the 401(k) until at least age 59 1/2.
IRAs do not allow for penalty free withdrawal options before age 59 1/2 because of a separation from service!
Check with your HR Specialist and ask them for a copy of your 401(k) Summary Plan Document/Definitions (SPD) which governs your company's 401(k). The SPD will spell out the rules of your company's 401(k), what withdrawals are allowed, at what age, and other rules that might govern 'penalty free' withdrawals.
Remember, no matter what you do, there are tax consequences. So, to avoid any 'gotchas', consulting with a tax expert is also recommended. In the meanwhile, here is a table from the IRS which shows information on penalties for early distributions by plan type.
Firstly, I think it is very smart that you are making sure to get your employer's match. If you are only considering retirement, I would max out the ROTH because it will grow tax free, provided you keep it until age 59 1/2. However, if you are more interested in building a nest egg for another goal, such as buying a home, the non-retirement account may be your best bet so you will have more liquidity and only capital gains taxes to think about rather than personal income tax.
Unfortunately, both 401(k) and IRA account withdrawals are subject to the 10% early distribution penalty before the age of 59 1/2. You may have already done this, but I would check with the 401(k) plan and see if they offer any options for penalty free withdrawals. We have seen some clients who have 401(k) plans that offer a way to take money out without triggering the penalty. Of course, before acting, make sure to consult your tax advisor.
Best of luck!