The best way to take money out of your 401(k) plan depends on three things:
Taking Money Out of a 401(k) Once You Leave Your Job
If you no longer work for the company that sponsored your 401(k) plan, first contact your 401(k) plan administrator or call the number on your 401(k) plan statement. Ask them how to take money out of the plan. Since you no longer work there, you cannot borrow your money in the form of a 401(k) loan or take a hardship withdrawal. You must either take a distribution or roll your 401(k) over to an IRA. Any money you take out of your 401(k) plan will fall into one of the following three categories, each with different tax rules.
Regular 401(k) Withdrawal
This applies if you no longer work for the employer that sponsored the 401(k) plan, and you are over age 59 1/2, (in some cases you only need to be over age 55, as long as you were 55 or older at the point you retired from that employer). With a regular 401(k) withdrawal, you will pay income tax on the amount you take out, but no penalty will apply because of your age.
Early 401(k) Distribution
This applies if you are not yet age 59 1/2 or don’t qualify for the age 55 regular withdrawal, and you’re no longer working for the employer that sponsored the 401(k) plan.
401(k) Rollover to IRA
You can do a rollover of your 401(k) account balance to an IRA at a company of your choice. You pay no taxes if you do a rollover to an IRA, and your money can stay in your IRA for your later use. Then you can withdraw money from your IRA only as you need it. You only pay taxes on the amount you withdraw each year. With the IRA, you will also have the option of using a special rule called 72(t) payments which allow you to take money out, and also avoid the early-withdrawal penalty. There are also exceptions to the penalty, depending on your status and how you plan to use your withdrawn funds.
Taking Cash Out When You Are Still Employed
Some 401(k) plans do not allow you to take money out of the plan while you still work for your employer. Other plans offer a few choices, such as a 401(k) loan, hardship withdrawal, or in-service distribution.
401(k) Loan
Many 401(k) plans allow you to take money out of the plan through a 401(k) loan in which you borrow against your account balance. The maximum amount of the loan allowed is usually the lesser of $50,000 or half of your vested 401(k) account balance. You will be charged interest, and while the money is out of the account, it’s not earning interest so, use this option only in emergencies.
401(k) Hardship Withdrawal
Some, but not all, 401(k) plans allow you to take a hardship withdrawal if your circumstances qualify under the hardship provisions.
In-Service Distribution
A few 401(k) plans allow you to take money out of the plan while you are still employed, by using this option.
What if You Are the Beneficiary of a 401(k) Plan?
If you are the beneficiary of a 401(k) plan, you’ll have a little bit different set of rules that apply to taking money out of the 401(k) plan. Your choices will depend on whether you were the spouse or non-spouse of the 401(k) plan participant and whether the 401(k) plan participant had reached age 70 1/2—the age for required minimum distributions (RMD).
The Bottom Line
Taking money out of a 401(k) plan means that you’ll be dipping into money that is being saved and invested for your future retirement. Consider your other options for additional cash, such as your emergency fund, a personal loan, or a home equity loan. Consider working with a financial advisor to best understand how taking money out of your 401(k) will impact the rest of your finances.
