2023 EP0930 | Financial Updates | 401k Withdrawal Rules: What You Need to Know

We want you to plan for success. Welcome to Planning Matters Radio. Peter, good to see you.

Everyone, welcome back. We have a really important topic today. 401k withdrawal rules, what you need to know. So most Americans, Peter, are tapping their 401ks because of financial distress. In fact, the number of people who made a hardship withdrawal surged 36 percent from the second quarter of 2022.

So we wanted to break down the basics. How can I withdraw money from my 401k without penalty? Well, first of all, wait till fifty nine and a half or after would be optimal because that's what it's intended for. But like you said, hardship and more people are having to tap into it. Now, if you don't have to don't write, don't take money out of that 401k just to go spend or take a vacation or buy a new car or what have you. It is this exclusion to the penalty is explicitly for hardships. You also shouldn't use the 401k like a piggy bank and take a loan because, yes, you're paying yourself back, but you're not making the progress that you otherwise would have. So you can take money out if you have that justifiable hardship like a medical circumstance, some educational expenses, the purchase of a first time home or a couple of the other ones. But I think it's unfortunate more and more Americans right now are tapping the 401k, classifying it as a hardship. And that that speaks to kind of the general financial wellness I think that we have as as a society. But if you do tap it as that hardship withdrawal, you can you may be able to avoid the 10 percent penalty if it is justifiable and does qualify.

Mm hmm. After the passage of the SECURE Act, making a hardship withdrawal became even easier. Can you explain that a bit?

Yeah. So before the SECURE Act, which was like right before COVID, it was 2019 that the SECURE Act passed and it was the acronym is setting every community up for retirement enhancement. But it actually allowed people a little bit greater access to the 401k. So I'm not sure it held up to the the acronym because if we're pulling money out of retirement accounts before retirement, is that really retirement enhancement?

I don't think so. And there were several other provisions, by the way. Anyway, before that, the employee or like the human resource department had to prove and justify on behalf of the employee that it was a hardship. Indeed, did qualify or the plan sponsor had to, whereas now employees can self certify. And I hate to think it, but I have to imagine that that's part of the reason why we're seeing more people do it, is that they don't have those requirements on the front end where they are having to prove that it is indeed a justifiable hardship.

Unfortunately, though, like those those those records can be scrutinized for years after the fact. And we might see some of that being clawed back and the penalties added. That's why I said you may be able to avoid the penalty. Now, you don't have to repay a hardship withdrawal, but you will have to pay income taxes. And of course, as you mentioned before, there is an opportunity cost, right? Yeah, it's not the loan and both the loan and the hardship withdrawal, both of those would have the opportunity costs. But with the hardship withdrawal, that's actually removing money permanently. You do have to pay the tax on that as well, maybe avoiding the penalty, whereas the loan is kind of vice versa. You you don't have to pay the penalty or the tax so long as you do repay it. But the loan, if you look for a better job, like many people do, career aspirations, right, or are unexpectedly laid off, that outstanding loan balance immediately becomes a withdrawal and you could end up paying tax and the penalty on it. And just to remind everyone, if you're not fifty nine and a half and you make that withdrawal not for a hardship, you are going to face a 10 percent penalty and income taxes. Right.

Now, there as with everything there, there are some exceptions, right? If you are fifty five, there's actually a way to do that. But again, these are retirement accounts.

We want and intend them for retirement. So the bottom line is just don't do it. Just don't do it and leave that money there because you will take advantage of the power of compounding interest and the growth power that the market can provide over time and it will be a much better end result in retirement for you. So, yeah, if you are younger than fifty nine and a half, you make that withdrawal. It's taxes because you've never made you've never paid tax on traditional 401K dollars. Plus, it's the 10 percent penalty. And we want to avoid any and all extra costs and expenses that we can. That can be a pretty hefty one. And just to talk through one more benefit, though, of having a Roth account, you can always tap your contributions without penalty, right?

Right. It's kind of the little known secret benefit of the Roth IRA. We all know about the main benefit is that we can grow money over our career and that growth is tax free and the income is tax free when we retire.

But here's the little lesser known secret is that the government would love to get that money back in taxable circulation. And so if you absolutely need to again, I would avoid it if you can. But if you absolutely need to, you can access and withdraw the original contributions you've made to your Roth IRA without the 10 percent penalty. And you've already paid tax on those dollars. So I have seen a few different strategies using the Roth as kind of a spillover for college educational expenses.

It's not necessarily the way that I would do it 100 percent of the time. But it's an interesting, again, kind of secret additional second benefit of the Roth IRA as compared to a 401K or traditional IRA. Really interesting to talk this through, Peter.

A lot of people, of course, are struggling with inflation and many other unknown expenses right now. Somebody wants to talk through their options and the best option for them. What's the best way to reach you?

Give me a call or even if you just want to order things in the optimal way for a secure retirement and you're looking at that. I talk through all kinds of issues with people. And the way that conversation starts is you hear hear us here or watch the podcast and then you give me a call at the office.

Nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. You can also start the conversation online. Rich on planning dot com is what it looks like. Rashan planning dot com rich on planning dot com. Or you can email me Peter at Rashan planning dot com. All right, Peter, thank you very much. Always a pleasure.

Thank you, Aaron. This has been Planning Matters Radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to seek investment tax or legal advice from an independent professional adviser. Any investments and or investment strategies mentioned involve risk, including the possible loss principle. Advisory services offered through Brooks own capital management, a registered investment adviser, fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management while insurance products pay a commission, which may result in a conflict of interest regarding compensation.