Cashing out isn't the only way for those who need it to get money out a 401(k). Many plans also allow employees to take loans from their 401(k) to be repaid with after-tax funds at pre-defined interest rates. The interest proceeds then become part of the 401(k) balance. The benefit of this type of loan is that the borrower repays himself -- by eventually putting the borrowed money back into the 401(k) -- rather than a bank.
If loans are permitted under terms of the 401(k) plan, the employee may borrow up to 50 percent of the vested account balance up to a maximum of $50,000 without the money being taxed. The borrower must repay the loan within five years unless the loan is used to buy a primary residence, and loan repayments must be made at least quarterly in substantially level amounts. If the borrower defaults on the loan, the money becomes a taxable distribution with all the same tax penalties and implications of a withdrawal.
401(k) account holders should also be aware of their options when changing jobs. A person who leaves one job for another can either keep his existing 401(k) money where it is or move it to another account. If the new employer doesn't offer a 401(k), the employee can move the money into an IRA. Money "rolled over" to a new account is not taxable until withdrawn. If the money to be rolled over is paid directly to the account holder (i.e. your former employer writes you a check for the amount in your 401(k)), the money must be transferred to a new 401(k) or IRA within 60 days. Since any taxable distribution paid directly to the account holder is subject to mandatory withholding of 20 percent, even if the person intends to roll it over, an employee seeking to roll over funds from a previous 401(k) should ask that the money be transferred directly to the new plan or IRA.
401(K) holders looking for extra cash should keep all these options in mind when considering whether to tap into retirement savings early. Other savings tools (particularly IRAs) may also provide penalty-free ways to get at money, depending on the holder's circumstances. For more information on 401(k)s and retirement savings strategies, check out the related articles and links below.
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More Great Links
- Browning, E.S. "Retiring Boomers Find 401(k) Plans Fall Short." The Wall Street Journal. Feb. 19, 2011. (May 16, 2011)http://online.wsj.com/article/SB10001424052748703959604576152792748707356.html?mod=WSJ_hp_MIDDLENexttoWhatsNewsTop
- CNN. "401(k)s: Top Things to Know." (May 16, 2011)http://money.cnn.com/magazines/moneymag/money101/lesson23/index.htm
- Rooney, Ben. "Unemployed tap their 401(k)s." CNN Money. Oct. 28, 2009. (May 24, 2011)http://money.cnn.com/2009/10/28/pf/hewitt_401k/index.htm
- U.S. Department of Justice. "Employee Retirement Income Security Act of 1974 (ERISA) -28 U.S.C. 1001." (May 16, 2011)http://www.justice.gov/usao/eousa/foia_reading_room/usam/title9/135mcrm.htm
- U.S. Department of Labor. "Retirement Plans, Benefits & Savings: Types of Retirement Plans." (May 16, 2011)http://www.dol.gov/dol/topic/retirement/typesofplans.htm
- U.S. Internal Revenue Service. "401(k) Resource Guide - Plan Participants - General Distribution Rules." May 5, 2011. (May 16, 2011)http://www.irs.gov/retirement/participant/article/0,,id=151787,00.html
- U.S. Internal Revenue Service. "Publication 590 (2010), Individual Retirement Arrangements (IRAs)." (May 16, 2011).http://www.irs.gov/publications/p590/index.html
- U.S. Internal Revenue Service. "Retirement Plans FAQs regarding Hardship Distributions." Nov. 17, 2010. (May 16, 2011) http://www.irs.gov/retirement/article/0,,id=162416,00.html