You know all about how to put money into a 401(k) or IRA, but how do you get out? Whether you are taking early withdrawals, normal distributions, or required minimum distributions, find out the rules for taking IRA and 401(k) withdrawals.
Most early withdrawals (those taken before age 59 1/2) from a 401(k) are taxed as ordinary income, plus a 10% penalty fee. The exceptions include disability, a layoff after age 55, a qualified domestic relations order
after a divorce, or death. But not only do you lose a good chunk of your savings to taxes and fees, you also lose that potential future savings growth. Tax-deferred savings growth, no less!
Early withdrawals from IRAs are also subject to ordinary income taxes, and that nasty 10% penalty fee. IRAs have the same exceptions to the penalty as 401(k)s: death, disability, divorce and QDRO, but there are a few others. You can withdraw the money early without the 10% penalty if you use the money to pay for qualified education expenses (yup, like college—but don't do it), you use it for medical expenses above 7.5% of your gross income, or you use up to $25,000 of the money for a qualified first home purchase. But again, any money you take out will not benefit from the tax-deferred investment growth that works better if accumulated over a longer period of time.
A Roth IRA withdrawal is completely different. Your investments did not grow tax-deferred in a Roth, and when you take distributions they will be tax-free provided you are at least age 59 1/2 and have held the Roth IRA for at least 5 years. There is also a 10% penalty for early distributions. But that's just on investment earnings. You can withdraw your contributions before age 59 1/2. This makes the Roth a really flexible savings tool.
If your employer allows it, a 401(k) loan is a better option than an early distribution. There's no credit check, the fees are generally low if any. And you must pay yourself back with interest, but it's low interest. If you are using the money to buy a house, you may have a longer repayment period. But on the cons side, you are paying yourself back after-tax, so you lose one of the main tax benefits of the 401(k). You also miss what could be crucial months or years invested in the market. If you can avoid touching your retirement savings at all, you probably should.
Normal distributions are those made after age 59 1/2. There is no penalty for withdrawing your money at this point. But if you are invested in a 401(k) or regular IRA, you will pay ordinary income tax on the distributions. The idea is that at that point, you will be retired and no longer collecting a salary, and therefore in a lower tax bracket.
If you reach age 70 1/2 and still have not retired, or just haven't started the withdrawal process, the IRS will start fining you 50% of the amount that was supposed to be distributed. It's called required minimum distribution, and it's only done with 401(k)s and IRAs. Roth IRA holders do not need to take required minimum distributions.