Rules of 401 K withdrawal & exceptions

 

Everyone is afraid of the penalties for early withdrawal from retirement accounts but most people do not know that there are other options even before full retirement age.

BASICS: For 401k accounts, 403(b) and 457 accounts, the 2015 contribution limit is $18,000 although people aged 50 and older can make an additional "catch-up" contribution of up to $6,000( $18,000 + $6000). In contrast, for an IRA the contribution limit for 2015 is $5,500 and an additional $1000 for people aged 50 and older.

WITHDRAWALS: For both regular and Roth 401k accounts, 59 ½ is the age when you can start withdrawing and then at age 70 ½ (or later if you have not retired) you are mandated to take distributions -- "required minimum distributions" (RMDs). The IRS has strict rules about how much you can withdraw. You can withdraw more but not less than a formula based upon life expectancy tables and the balance in your account at the end of the previous year. If you withdraw less, you may be liable to pay an excise tax of 50% of the amount you failed to withdraw.

There are other options for withdrawing before age 59 ½.  A ‘hardship’ withdrawal, significant and permanent disability and also If you leave your employment at or after age 55, you can  withdraw from the 401k setup with that employer.

Is there an exception to the tax for distributions in substantially equal periodic payments?

The IRS says “An additional 10% tax applies to early distributions (before the participant reaches age 59½) from a retirement plan or IRA under Code §72(t)(1). Section 72(t)(2) lists exceptions to this tax, including distributions received in substantially equal periodic payments.”

So, what most people do not realize is that there is another exception called the ’72 t’ exception which states: “if distributions are made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary, the §72(t) tax does not apply.” One has to use life expectancy or mortality tables to calculate this and need a professional lest penalties are imposed!