DO YOU KNOW THERE ARE WAYS TO DO PENALTY–FREE EARLY WITHDRAWALS FROM QUALIFIED PLANS FOR INDIVIDUALS UNDER AGE 59½?
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Estate Planning Attorney
A retirement plan (401K, SEP) is often a persons largest asset. Accessing those funds prior to age 59½ without a penalty may be critical. Here’s how to do it:
The IRS has updated its guidance regarding early withdrawals from qualified accounts. This article deals with the various methods of taking early (i.e., pre-59½) withdrawals from 401(K)s and IRA’s without incurring the percent penalty.
Penalty-free withdrawals from a 401(K) or IRA can be done if the account owner:
- Becomes totally disabled;
- Has medical expenses that exceed 7.5 percent of adjusted gross income;
- Is required by court order to give money to a divorced spouse (i.e., a QDRO);
- Loses his/her job (through permanent layoff, termination, quitting or taking early retirement) in the year the account owner turned 55 or later; or
- Takes withdrawals in substantially equal amounts over the owner’s life expectancy that:
- Must be paid at least once each year;
- Must be based on the life expectancy of the plan participant or the joint life expectancy of the participant and a designated beneficiary; and
- Must not be modified before the later of five years after the first distribution or the date on which the plan participant reach age 59 ½.
Additional Withdrawal Opportunities for IRA’s
In addition to the above, there are three additional means of withdrawing funds pre-59½ years of age from an IRA (but not a 401(k)):
To pay health insurance premiums during a period of unemployment lasting at least 12 consecutive weeks;
To pay for higher-education expenses for the account owner or the account owner’s spouse, child, or grandchild, but only if the distribution is used to pay for tuition, fees, books, supplies, equipment, or room and board and is net of any scholarships; or
To pay up to $10,000.00 of the costs of purchasing (not refinancing) a first home, defined as someone who did not own (and whose spouse did not own) a principal residence in the two years preceding the distribution from the account.
Additional Withdrawal Opportunities for 401(k)s – Hardship Withdrawals
A 401(k) plan may allow employees to receive a hardship distribution because of an “immediate and heavy financial need” and the distribution is “necessary to satisfy that financial need.” Hardship distributions from a 401(k) plan are limited to the amount of the employee’s contributions and generally do not include any income earned on the deferred amounts.
A distribution is deemed to be on account of an “immediate and heavy financial need” of the employee if the distribution is for:
Expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care (note that there is no 7.5 percent of AGI requirement);
Costs directly related to the purchase (not the refinancing) of a principal residence for the employee, not to exceed $10,000.00 but only if no home has been owned in the previous years;
Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of post secondary education for the employee, or the employee’s spouse, children, or dependents;
Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;
Funeral expenses; or
Certain expenses relating to the repair of damage to the employee’s principal residence.
There are no “hardship withdrawals” from IRAs. However, IRA funds can always be accessed for any reason and at any time but the 10 percent early withdrawal penalty will apply.
Loans from 401(k)s
Rather than taking a taxable distribution from a plan, a 401(k) plan participant can often take a loan in accordance with Internal Revenue Code section 72(p)(2)(A). Note that loans cannot be made from IRAs. The statutory conditions that must be satisfied are:
Loan cannot exceed the lesser of $50,000.00 or half the participant’s non-forfeitable account balance. (The $50,000.00 limit is reduced if there were outstanding loans during the one-year prior to issuing the new loan.)
Loan must be repayable within five years or, if used to acquire a principal residence, 15 years.
Repayment must be required in substantially level payments, not less frequently than quarterly.
Loan is evidenced by a written, enforceable agreement.
Advantages of a loan from a qualified plan:
Quick and convenient. There is no credit check or long credit application form. Some plans only require a phone call, while others require a short loan form often available on the Internet.
There is a low interest rate. You pay the rate set by the plan, usually one or two percentage points above the prime rate.
There usually are no restrictions or conditions. Most plans allow borrowing for any reason-no financial hardship need be shown.
The participant is both lender and borrower. Interest is paid to the participant’s account, not to the bank or credit card company.
The interest is tax-sheltered. The plan does not pay taxes on the interest until retirement, when the money is taken out of the plan.
For more information, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at firstname.lastname@example.org.
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Monmouth County, Ocean County, Essex County, Cape May County, Camden County, Mercer County, Middlesex County, Bergen County, Morris County, Burlington County, Union County, Somerset County, Hudson County, Passaic County
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