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  • Nate Carter

Access Your 401(k) Money Before Age 59.5

One key drawback of tax deferred retirement plans like the 401(k) is you can't begin withdrawals until the age of 59½ without paying income taxes and a 10% penalty on the money. However, the good news is there are options to access these funds at age 55 or younger.

Option 1: Rule of 55 is an IRS waiver, under the Internal Revenue Code, that allows an employee who are fired, laid off or quit a job between the ages of 55 and 59½ to withdraw money from their 401(k) account without having to pay the 10% penalty. The Rule of 55 only allows for 401(k) distributions from your current employer, you cannot access 401(k) plans from previous employers. The Rule of 55 does not apply to 401(k) accounts that were rolled over into another type of investment account such as an Individual Retirement Accounts (IRAs) which is a frequent practice when changing jobs. Any assets that were rolled into an IRA when you left your previous job won't be accessible under Rule 55.

Option 2: A second waive is a Section 72(t) distribution under the Internal Revenue Code (IRC) Section 72(t)(2)(A)(iv) for those who leave their job before the age of 59½. This approach is also referred to as a Substantially Equal Periodic Payment (SEPP) exemption. Under a 72(t) distribution the employee calculates their life expectancy and uses that information to calculate five “substantially equal” payments from a retirement plan for five years in a row before the age of 59½. Life expectancy data can be found by consulting actuarial tables, available on the Social Security Administration’s website, or by looking up Section 72(t) calculators online. Once distributions begin they must continue unmodified for five years or until the recipient is 59½ years old. After distributions begin any modifications will trigger the 10% early withdrawal penalty retroactively to the first year of distribution. Unlike the Rule of 55, an employee can take the distributions at any age under Section 72(t) and do not have to be 55 years old.

Option 3: The current standard deduction for singles is $12,000 and $24,000 for married couples. If you make an early withdrawal below these thresholds and this is your only income for the year; you will not pay any federal income tax on the distribution even though it was an early withdrawal. You would still be liable for the 10% penalty but that would only be $1,200 for singles and $2,400 for married couples.

Option 4: If you have major medical expenses that are not reimbursed by an employer or by your insurance. In these circumstances you are able to make a withdrawal from your 401(k) plan. The medical expenses are those expenses that are greater than 10% of your adjusted gross income for the year. If an account owner suffers total and permanent disability they are able to access their entire 401(k) account without penalty. If the account owner dies, their heirs will receive the account proceeds without a penalty.

Option 5: This one a more limited section of the population, but is a great benefit if you qualify. If you are a military reservist called to active duty you may make certain qualified distributions from your account without penalty, see Internal Revenue Code section 72(t)(2)(G). Also, if you are a government employee who separates from service at the age of 55 or older you may access your 401(k) account without penalty. In addition, if you are a government employee deemed to be a public safety employee (including federal law enforcement officers, customers and border protection officers, federal firefighters and air traffic controllers) and you separate from the service on or after the age of 50 you may be able to access your 401(k) account without penalty. See IRC Sections 71(t)(2)(A)(v) and 72(t)(10).

Option 6 :This option is a bit more complex; it is called a Roth Conversion Ladder and comes from the website which also provides a nice graphic to help explain the process. There are four steps to follow explained below by using Sam as an example.

First, when Sam decides to leave her job, she immediately rolls her 401(k) into a Traditional IRA account. This rollover is a rather effortless process that will not incur any taxes or penalties for Sam.

Second, Sam decides she needs $25,000 five years from now. Sam converts $25,000 now in the Traditional IRA to a new Roth IRA. Sam will pay income tax now on the amount she converts to the Roth IRA, so it is preferable that she does this conversion at a point in the year when her income for the year is lower so she does not get pushed into a higher tax bracket. For example, Sam could implement this strategy and convert $25,000 in March if she knew she was not going to take another job for the rest of the year. Her total income is relatively low for the year so her conversion will not be taxed at a high marginal rate.

Third, Sam waits for five years. During this five-year period, she could convert another $25,000 every year from her Traditional IRA to her Roth IRA. By adding the additional annual conversions, she builds a ladder in the future in which a tranche of $25,000 is available each year. The funds from Sam’s first conversion will mature in year five and the funds from the second conversion mature in year six and so on, for as long as she has converted funds from her Traditional to her Roth IRA.

Fourth, after the five years have passed, Sam can withdraw the amount she converted to the Roth IRA without paying any income taxes as these funds were taxed when she made the original conversion during the second step. There are also no 10% early withdrawal penalties,

Exercise Some Caution on Withdrawals

Regarding 401(k) accounts in general, it is important to also exercise some caution in tapping these funds early through ladders or other strategies. Remember your retirement could be 40 to 50 years long and you want to have enough resources to cover this period. In addition, if a major market downturn occurs it is not the time to take distributions from your 401(k) account; it is preferable to wait to allow the account balances to recover. It is also wise to be conservative in your distribution calculations (an annual withdrawal rate below 4% per year) if you expect your 401(k) account to provide distributions for 30 years or more.


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