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The Nuts and Bolts of a 401(k) plan


Your Money Stays in the Plan

There aren't many catches to a 401(k) plan. But the one big catch is that once your money is in the plan, you'll have to pay a penalty if you withdraw the money too soon (generally before age 59½), as well as the ordinary income tax you will pay on any withdrawal. See the section Your 401(k) When Switching Jobs for information on the early withdrawal penalty. To be safe, plan on leaving the money and its earnings in a qualified plan until you retire (no earlier than age 55) or reach age 59½.

Early Access to your 401(k) savings

If you decide that you really need to take money out of your 401(k) plan to which you contributed pre-tax dollars, there are three ways you can do so.

  1. The most favorable way is to take a 401(k) loan. Most plans will let you borrow money from the plan, for almost any reason. The loan must be paid back with interest over time. The maximum payback period allowed by the IRS is five years, unless the money is used to purchase your principal residence, in which case the maximum could be 30 years.
  2. Most employers' plans will let you take out your money if you have a financial hardship, which the IRS defines as an immediate and heavy financial need. This is called a hardship withdrawal. If you take a hardship withdrawal, you'll have to pay ordinary income tax and possibly the 10% penalty tax (if you take a withdrawal before age 59½ or prior to retirement at age 55) on the amount you take out.
  3. In addition to withdrawals and loans, there are other times when you can access the money in your 401(k) plan. For example, if you become disabled or you die, you or your beneficiary can get your 401(k) money without any penalty.

If you are over age 59½ or meet other exceptions to the 10% early withdrawal penalty, you can withdraw your 401(k) money without penalty provided your employer's plan allows such distributions. You will have to pay ordinary income tax on the amounts received. See the section Your 401(k) When Switching Jobs for more details.

Read the section Pre-Retirement Withdrawals for more details about loans and hardship withdrawals. Also see the section Distributions from your 401(k) at Retirement for details on taking retirement distributions.




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