Find out how to use an in-service 401(k) withdrawal to buy a home without penalty when you’re over age 59½.
A reader named Carol asks:
“If I’m a 64-year-old male who is still employed, what are the tax consequences of withdrawing $100,000 from my retirement account to buy a home for my adult child?”
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Carol didn’t specify the type of retirement account he owns, but I’ll assume that he wants to take a 401(k) withdrawal.
What Is a 401(k)?
A 401(k) is a popular workplace retirement plan that allows employees to contribute a portion of their wages on a pretax basis. You defer paying tax on both contributions and earnings in the plan until you take a distribution in the future.
Taking a distribution before age 59½ is considered an early withdrawal, subject to a 10% penalty, in addition to ordinary income tax (unless an exception applies).
However, a 401(k) withdrawal can only be made when:
employment is terminated
an employee retires
an employee becomes disabled or dies
an employee suffers a qualified financial hardship
an employee reaches age 70½ and is required to begin taking distributions
Since Carol is still employed, doesn’t have a hardship, and is younger than age 70½, he isn’t eligible to take a distribution—unless his 401(k) offers a special option known as an in-service withdrawal.
What is an In-Service Withdrawal?
An in-service withdrawal is a feature of some workplace retirement plans that allows participants age 59½ or older to access all or a portion of their money while they’re still working and contributing to the plan.
In-service withdrawals can be cashed out, which subjects them to ordinary income tax. Or they can be rolled over into an IRA (Individual Retirement Arrangement) with no tax consequences, if done in a timely manner.
If Carol’s retirement plan offers an in-service withdrawal, taking a distribution simply adds the amount to his taxable income. For instance, if his salary is $50,000, taking a $100,000 distribution would bump up his taxable income for the year to $150,000.
Another option for Carol to tap his retirement funds for any reason is to take a 401(k) loan from the plan, if that’s an option. Loans are another feature that workplace plans are allowed to have, but may not offer.
To find out if your retirement plan offers loans or in-service withdrawals, read the plan document, ask the benefits administrator, or contact the plan’s custodian for advice.
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