Any amounts withdrawn from your 401(k) plan must be treated as ordinary income for the year the amount is distributed from your 401(k) account.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.
Steve Stanganelli, CFP®, CRPC®, AEP®, CCFS
Clear View Wealth Advisors, LLC, Amesbury, MA
You may access your 401(k) to fund your living expenses. But it must be a withdrawal: You will not be able to take out a loan as you could have when you were an employee, but will instead have to pay it back by the due date of your federal income tax return that year.
How much this costs you depends on your age. If you're over 59.5, you won't have to deal with the 10% early withdrawal penalty. If you're under 59.5, you'll have to pay the penalty, unless you use the funds for medical expenses that total more than 10% of your gross income. Then you'll likely be eligible for an exemption. You can also avoid the penalty via the 72(t) rule: receiving "substantially equal periodic payments" over the next five years.
In all cases, your distributions will be counted as income in the year of withdrawal, and you’ll owe tax on them. It may help to have the 401(k) custodian withhold a percentage for taxes with each distribution.