For millions of Americans, 401(K) and/or IRA accounts figure largely in their retirement plans. But the two methods of saving are regulated by different rules and knowing those rules is important when you are ready to take money out of the accounts.
A 401(k) may be involved in your employment compensation package and many employees want to take money from that savings when they leave the company.
The Internal Revenue Service imposes a 10 percent penalty for early withdrawal of IRA savings if you are under the age of 59.5, but the rule does not apply for 401(k) plans. For the latter, the rule does not apply if you are over 55 years of age, so you don’t have to wait until you have passed your 59.5 mark to take out the money.
However, if you do withdraw from your 401(k), you will have to pay taxes on whatever amount you take.
There are several categories of employment that qualify 401(k) holders to avoid the early withdrawal fee as early as 50 years of age. These include public safety employees such as policemen and firefighters, and emergency medical service providers for states or municipalities who leave the service in or after the year they turned 50.
There are publications that will help you determine how best to manage your retirement accounts. IRS Publication 575, titled Pension and Annuity Income, is one of these. It is online at www.irs.gov. It contains sections on separation from service and other specific elements of how to manage income from the retirement plans.
IRAS have different qualifying rules. You face an early withdrawal penalty if you take money from your IRA before you are 59.5. Any money you take out before then is subject to a 10 percent penalty and also is taxable. An exception may be possible under Section 72(t) of the Internal Revenue Code, but that requires that you commit to a series of substantially equal periodic payments.
Because the rules differ and are complex, financial experts advise that you involve an accountant at the outset. When you finally are serious about withdrawing IRA funds before you have reached the required age, you may need advice, because once you have chosen a formula, you are required to keep the same method.
A distribution form will ask you to choose among several formulas for receiving payments and whether or not it qualifies for an exception from the IRS penalty. Your chosen accountant or IRA custodian probably will have information, including a pamphlet that sets out the IRS requirements. The tax form that you may have to file in the process – Form 5329 – also outlines the guidelines for exclusions. Another resource is “Retirement Topics, Exceptions to Tax on Early Distributions” an IRS chart that shows exceptions to the 10 percent penalty. In addition, the IRS Publication 590 delves into individual retirement arrangements. It is free by calling 1-800—TAX-FORM.
Again, a word to the wise. Get expert help. Tax issues are not the category on which you want to do the do-it-yourself thing.