The 401(k) plan is the staple for retirement in America. Next to social security, a 401(k) is meant to provide you with additional income for your retirement. However, accessing the funds held in your 401(k) isn’t possible until you reach age 59.5 unless you want to pay a 10% penalty. This can pose issues for people who need to get access to money before their social security kicks in. So what are your options for getting money out of your 401(k) without paying taxes?
In this article, we will discuss qualifications and ways to access the funds inside your 401(k) without paying taxes or getting hit with a penalty.
How Can I Get My 401k Money Without Paying Taxes?
There are essentially 5 qualifying circumstances in which you can access your 401(k) funds without paying taxes or getting hit with the 10% early withdrawal penalty.
- 401(k) Loan
- Hardship Withdrawal
- Medical Expenses
- Roll Your 401(k) into a Self-Directed IRA
A 401(k) loan is a fantastic solution to help you get access to the funds in your 401(k) account. This will depend on your 401(k) plan structure and management, however, most plans permit plan participants to take out a loan. Most plans allow borrowers to access up to 50% of the balance in the 401(k), with a maximum of $50,000.
Taking a loan out allows you to get access to the balance without paying the 10% early withdrawal penalty. In addition, you won’t have to pay income taxes because it’s a loan.
Another great thing about taking out a 401(k) loan is that your funds continue to stay invested. This allows your retirement to continue growing while you have the money for something you need. A 401(k) loan also has very favorable interest rates compared to personal loans. Interest rates for 401(k) loans tend to be between 4-6%.
Lastly, 401(k) loans have very flexible repayment terms. Most plan providers will allow repayment terms ranging from 3-10 years. In addition to the favorable repayment terms, most plans don’t have an early repayment penalty. All these features of 401(k) loans make them a great option to consider if you want to access the funds without paying taxes or penalties.
A hardship withdrawal allows you to tap into your 401(k) balance without incurring a penalty provided that you mean certain eligibility requirements. It’s a type of penalty-free withdrawal option that requires you to have an immediate and heavy financial burden that you can’t pay in any other way.
It’s important to note that while some of these hardships will allow you to sidestep the 10% early withdrawal penalty, you will still have to pay income taxes on the money you use.
In order to qualify for a hardship withdrawal, the expense of the hardship is taken into consideration, as well as your other assets and investment accounts. Below are the most common hardship withdrawal expenses:
- Medical expenses and treatment
- Down payment for a primary residence
- Education and tuition fees
- Expenses to prevent foreclosure, bankruptcy, or eviction
- Funeral expenses
- Expenses to repair home damages not covered by insurance
Important Note: The down payment for a primary residence qualification is extended only if the borrower doesn’t have any other source of funds for the down payment. The amount extended will be limited to the amount required for the borrower to qualify for a mortgage.
It’s worth noting that when you take a hardship distribution you may not be able to contribute to your retirement account for 6 months after you receive the distribution.
Another way to get access to your 401(k) funds is if you need the money to cover medical expenses. Penalty-free withdrawals are allowed for medical expenses that exceed 7.5% of your adjusted gross income. This would waive the 10% early withdrawal penalty.
This is extended for medical expenses not covered by your health insurance provider. In order to avoid the 10% fee, the withdrawal must take place in the same year the patient received treatment.
If you become permanently disabled you can access your 401(k) funds. The disability clause in your 401(k) allows you to access the funds before you turn 59.5 and waives the 10% penalty. This will require you to prove to that you are unable to work and will require a government agent to come out and certify that you are unable to work.
It’s worth noting that you will receive some sort of disability payment from social security. Tapping into your 401(k) account should only be done if you really need extra money.
Roll Your 401(k) into a Self-Directed IRA
One unique option for accessing your 401(k) funds is to roll it over into a self-directed IRA. You can transfer or roll your 401(k) balance to a self-directed IRA if you retire, quit your job, or get fired. A self-directed IRA allows you to control the assets in the account.
Recommended Reading: 403(b) Rollover Rules: Different Rollover Options and Benefits
This means that if you wanted to use your 401(k) funds to invest in assets such as real estate, non-traded business, or an alternative asset, you can do so through a rollover into a self-directed IRA. This will require a trustee or custodian that specializes in this area to help you complete the rollover procedure. If this is a route you want to take, we highly suggest speaking with a licensed financial advisor.
What Proof Do You Need for a Hardship Withdrawal?
In order to qualify for a hardship withdrawal, you need documentation of the hardship application or a formal request including approval of the request. Proof can be medical bills, insurance bills, escrow paperwork, mortgage documents, funeral expenses, bank statements, and more.
Do You Have to Pay Back a 401(k) Hardship Withdrawal?
Unlike a 401(k) Loan, the funds from a hardship withdrawal do not have to be paid back.
How Long Does it Take to Get Funds From a 401(k) Loan?
Once you fill out the necessary paperwork requesting a 401(k) loan, it takes approximately 1-2 weeks for the funds to hit your account.