5 Things You Need To Know About The 401K

You know you’re supposed to plan for your retirement.  With social security on the road to bankruptcy, those who are paying into the system now will likely never enjoy the benefits of their investment.  There are all kinds of options to save money for your golden years, from CDs to IRAs to stocks and bonds to actual savings accounts, but the best way to ensure that your time as a senior citizen is spent in relative comfort is to contribute heavily to the 401K plan offered by your place of employment (especially if they submit a certain percentage of matched funds).  And while the plan is generally the same for every person (put money in throughout your occupational tender, withdraw it upon maturation, usually at the age of 59 ½ or above), there may come a time when you are either tempted to withdraw funds early or you feel that you have no choice but to take money from your 401K.  Unfortunately, this course of action could come with some hefty drawbacks.  Here are a few things you should know before you decide to approach the teller window bearing a withdrawal slip.

1. Taxation.  Although the money you contributed to your 401K was taken from your paycheck pre-tax, that doesn’t mean you can get it out the same way.  These funds are considered tax deferred, which means the IRS wants their share as soon as the money leaves the protective umbrella of the account.  So in preparation for tax time, you may want to take enough money to cover the bump in “income” you might have for the year.
2. Penalties.  A 401K is a long-term account and as such, it comes with certain restrictions, one of them being the date of maturation.  If you pull funds early, you will be penalized, to the tune of at least 10% (this is across the board, although you may have further penalties).  So if you take $50,000, for example; in addition to the percentage you will owe in income tax, you will also lose a minimum of $5,000 right off the top.  Ouch.
3. Exemptions.  Luckily, there are ways to get cash from your retirement account without facing penalties (although income tax cannot be escaped).  Early job separation (age 55 plus), medical bills (that total more than 7.5% of your adjusted gross income), and death (pertaining to payments to beneficiaries), are just a few valid reasons for withdrawal without penalty.
4. Loans.  Some plans come with an option to take a loan against your 401K (it is, after all, your money).  The problem is, this type of account is not exactly set up, legally speaking, to release assets before maturation.  However, if your company had the foresight to pay a little extra for this feature, you may withdraw funds for any reason (unless your company has their own policies in place on the matter).
5. Payback.  While there are no legal restrictions pertaining to reasons for taking loans on your account, the only way it can be considered a legal loan is if you pay interest, which is generally lower than you would owe to, say, a lending institution.

This was a guest post from Leon Harris.