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Question for the Money Doctors

Question submitted on Oct 23, 2018.

Question

I read from your site that you can withdraw from a retirement account with 10% penalty before 59 1/2 (although, you mentioned it was an IRA.) I wanted to withdraw from 401k for new roof and they would not let me (even with penalty and tax). They said a tornado would have to rip it off in order to withdraw. How can some people get money out just for bills?

Thanks.

Answer

Although IRAs and 401k plans have many similarities, there are some important differences for participants to keep in mind.  One of these concerns your ability to take money out of the account.  Since an IRA is most frequently an account that a person maintains with a bank or other financial institution, the money in the account can usually be withdrawn whenever the account owner desires.  Of course, the withdrawal will result in taxable income and, if the account owner is younger than 59 1/2, a 10% penalty tax unless a specific exception applies.  A 401k plan is maintained by an employer and has a number of rules that the employer is required to follow.  The rules concerning when a 401k plan participant is allowed to take his/her money were not intended to make it easy for someone to withdraw money before retirement.  So the conditions under which a plan participant who is younger than 59 1/2 is allowed is allowed to withdraw money are even more restricted.  Most plans will allow you to take your money if you leave your job, of course.  But, if you are not changing jobs, the plan is not required to allow a participant to take an "in service" withdrawal if he/she is younger than 59 1/2.  If the plan does allow such withdrawals, it is only allowed for certain specified reasons.  One of the permitted reasons is for a financial hardship caused by needing to repair damage to an employee's principal residence.  On a few occasions, special laws have been passed to allow distributions to be made to repair damage caused by Hurricanes Katrina, Harvey, Irma & Maria but those have been limited in scope.  As you noted, even if your plan allowed hardship withdrawals, you would still need to pay the 10% penalty in addition to the income tax on any money that you would take out.  The IRS has issued some guidance on what rules a plan must follow if it allows hardship withdrawals and here's a link  https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-hardship-distributions 


For additional information visit http://www.360financialliteracy.org/

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