Debt Free

It's one of the most common retirement planning questions; What are the consequences of early withdrawal from my 401k plan? If you've reached that station in life where you're ready to jump into the Prevost and head to Scottsdale for a few rounds of golf, you may want to withdraw some of your 401k funds to finance the trip. This could trigger some problems for you financially unless you are one or more of the following:

1. Dead - Yes, it's true, the IRS will let you take you funds from your 401k or other qualified retirement vehicle if you're dead. Of course it will be kind of tough to nail that hole in one on the 11^th at Estancia if you're dead, so maybe you'll have to look for other ways of avoiding the 10% early withdrawal penalty, such as ....

2. You're over age 55 and have retired or quit your job. There, that's more like it! You can be alive, 56 years old and enjoying some sun out on the course while spending the fruits of your old employer's 401k matching contribution.

3. You got a divorce and the judge declared that you have to split the 401k as part of the divorce decree. In that case, avoiding the 10% penalty is probably the last of your worries, financial and otherwise.

4. The cost of that expensive hip replacement you had to get so you could keep golfing was greater than 7.5% of your adjusted gross income and you withdrew 401k funds to pay for it. Seriously, if you withdrew funds to pay for medical expenses that were greater than 7.5% of your adjusted gross income, and you itemized your deductions, you can avoid the IRS early withdrawal penalty.

5. The withdrawals meet the "substantially equal payments" criteria. The substantially equal payments criteria means that the payments must be “part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee “ The section of the Internal Revenue code that deals specifically with this topic is section 72(t)(2)(A)(iv). According to the IRS, other qualifying methods of avoiding the 10% penalty according to the SEP criteria are:

   A) “the amount to be distributed annually is determined by dividing the taxpayer's account balance by an annuity factor (the present value of an annuity of $1 per year beginning at the taxpayer's age attained in the first distribution year and continuing for the life of the taxpayer) with such annuity factor derived using a reasonable mortality table and using an interest rate that does not exceed a reasonable interest rate on the date payments commence. “

   -or-

   B) “if the amount to be distributed annually is determined by amortizing the taxpayer's account balance over a number of years equal to the life expectancy of the account owner or the joint life and last survivor expectancy of the account owner and beneficiary (with life expectancies determined in accordance with proposed section 1.401(a)(9)-1 of the regulations) at an interest rate that does not exceed a reasonable interest rate on the date payments commence.” Got that?? It basically means that you can guess how long you're going to live according to a generally accepted life expectancies table and then treat your 401k as an annuity that pays out at a reasonable interest rate.

The IRS (and I) recommends that if you are attempting to qualify for the substantially equal payments criteria, you hire a professional financial planner, attorney, or accountant that is well versed in this particular area. Failure to qualify could result in the obligatory IRS fees and penalties levied at those who would make tax mistakes, willful or accidental.

So, you can get an early withdrawal from your 401k plan if you play by the IRS rules. The other option is to throw caution to the wind, say “What the hell, you only live once” and generously contribute the extra 10% to the American people (Where of course it can be frittered away in the bureaucratic morass that is our Federal Government).