Thinking of taking a withdrawal from a retirement account while you’re still working? There’s a lot to consider.
Understand there is a difference between taking a withdrawal and taking a loan from your employer-sponsored plan. Just as with a regular loan, when you take a loan from your 401(k) you will pay back the amount you take out, with interest. For the purposes of this article we’re focusing just on withdrawals— taking money out of your employer-sponsored retirement plan that you will not be able to pay back.
With that distinction out of the way, you’ll need to review additional information to know what will be available to you.
From what plan type would you take the withdrawal?
401(k): If you are younger than age 59½ and still working for the employer offering the retirement plan, the IRS only allows you to take 401(k) withdrawals in the face of an immediate and heavy financial need. That could include:
A hardship withdrawal, as described above for someone under the age of 59 ½, will be subject to ordinary income tax and a 10 percent IRS early-withdrawal penalty.
Taking a hardship withdrawal from a 401(k) plan, subject to meeting the IRS requirements, may be possible though your employer may have additional requirements or more stringent rules. Check your plan document to see whether the option is available to you.
403(b): The rules are essentially the same as those governing 401(k) withdrawals.
Thrift Savings Plan: TSP participants who wish to take a withdrawal must similarly prove a financial need. Unlike a 401(k) plan, if a significant need exists, the TSP is legally required to allow the withdrawal. After you've separated from employment, you can take a partial or full withdrawal prior to reaching age 59½. TSP early withdrawals are subject to ordinary income tax and a 10 percent IRS penalty.
457: The rules governing a 457 withdrawal are stricter. There must be an unforeseeable emergency, so home purchase and college tuition expenses aren't eligible criteria. If you've separated from employment, you can take a 457 withdrawal for any reason. It will be subject to ordinary income tax, but there is no additional IRS penalty.
Are you currently working past age 59½?
If you’re at retirement age but still working, there aren't IRS restrictions about withdrawals. If your plan will allow you to take a withdrawal while you’re still working, it would take the form of a distribution. However, your plan document may be stricter than the IRS, so check to see whether you’re eligible to take an over-59½ in-service withdrawal. You may want to talk with a financial adviser before making this decision.
Is it worth it?
Your retirement nest egg could determine how you spend the final quarter or third of your life.
Withdrawing money from a retirement account before retirement age should be a last resort. A little less money invested (or a lot less) may not seem like a big deal to you right now. But you’ll erode the benefits of compounding rapidly if you take early withdrawals. Actions you take now could directly affect the age at which you’re able to retire and the lifestyle you’re able to have during retirement.
Additionally, early withdrawals from many plan types trigger an IRS penalty that’s just a tough pill to swallow.
Non-emergency situations, like paying for college and home purchases, may not warrant early withdrawals. Perhaps renting a home rather than buying one isn't your dream, but it’s not the end of the world. And, with the availability of student loans and scholarships, it’s difficult to justify upsetting your retirement plans to pay for college. After all, there’s no such thing as a retirement scholarship!
Think long and hard before you take money out of your retirement nest egg. Consider contacting a financial adviser and a tax adviser to talk through your overall plan before making any decisions. Be certain it’s a true emergency and you have no other way to get the money you need.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.