I read that at age 55 I can withdraw my 401(k) without penalty as long as I am leaving my job. Is this true for all 401(k) plans? Are there any specific reasons one has to have for withdrawal without penalty? I need to use the funds to pay off bills and debts.
A 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pre-tax basis. These deferred wages (commonly referred to as elective deferrals) are not subject to income tax withholding at the time of deferral, and they are not reflected on your Form 1040 since they were not included in the taxable wages on your Form W-2.
However, they are included as wages subject to Social Security, Medicare, and federal unemployment taxes.
Some plans allow employees to make a 401(k) hardship withdrawal because of immediate and heavy financial needs. Generally, 401(k) hardship distributions are limited to the amount of the employee’s elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.
A 401(k) hardship withdrawal is not like taking a loan from your 401(k) account. The withdrawal may be difficult to get, and costly to receive. Your 401(k) is intended to provide retirement income and should be a last-resort source of cash for expenses. IRS rules allow plan withdrawals (called distributions) in a limited number of hardship situations. To further discourage early withdrawals, Congress wrote harsh rules to impose a penalty tax in many situations.
Congress allowed two types of hardship withdrawals in 401(k) and other deferred-tax retirement savings plans. One subject to applicable income taxes plus a 10% early withdrawal penalty tax if you are younger than 59½. The other is a penalty-free withdrawal made under Section 72(t) of the Internal Revenue Code. With this, you pay applicable income taxes but not an early withdrawal penalty tax.
You may receive a 401(k) hardship distribution because of an “immediate and heavy financial need” and the distribution “is necessary to satisfy that financial need.” Let's look at the rules for penalty and no-penalty distributions, as found in IRS document Topic 558 and the IRS 401(k) Resource Guide - Plan Participants - General Distribution Rules. Refer to both of these documents for clarifications on the rule below.
According to the IRS, the following reasons may be allowed by your plan's administrator for a 401(k) distribution:
According to the IRS, the following reasons may be used for a penalty-free 401(k) distribution:
Plan administrators and employers are not required to offer either type of 401(k) hardship withdrawal, so check with your administrator to learn which type of distribution, if any, is available to you.