28 Nov Taking money from 401(k) without penalty

Q. What are the exceptions for taking money from a 401(k) without penalty? Can you leave your current employer in the calendar year you turn 55 — so you can theoretically leave in January at age 54 if you turn 55 before the end of the year?
— Planning it out

A. There are a number of exceptions that allow 401(k) account owners the ability to withdraw money from their plans prior to age 59 ½ without incurring the standard 10 percent early distribution penalty.

One of the exceptions is the one you ask about, said Chadderdon O’Brien, a certified financial planner with RegentAtlantic in Morristown..

“If you are considered a qualified public safety employee — think state and local government — the age threshold to avoid the early distribution penalty is 50,” he said. “In your example, the separation of service at age 54 and the attainment of age 55 occur in the same calendar year so you meet the criteria to use this exception.”

O’Brien said the age and year of the separation of service is the important date, not when the plan is actually distributed.

For example, he said, if you separated from service at age 53 and waited until age 55 to distribute the plan, you would be subject to the 10 percent early distribution penalty.

It is worth mentioning, however, that in your scenario the full 401(k) distribution will be taxable as income, O’Brien said. Depending on the size of your plan, the spike in your taxable income may increase your overall tax rate and result in a net of tax distribution that is significantly less than you planned for.

Depending on the circumstances around your cash need, accessing money from other resources may be a better option, O’Brien said.

“For example, monies withdrawn from an after-tax investment or savings account would likely result in a lower tax impact,” he said. “A line of credit on the equity in your home is another alternative.”

If the 401(k) is your only available option make sure to take the distribution before rolling the plan into an IRA, O’Brien said.

IRA rules differ from the 401(k) rules and do not contain the separation from service provision, he said.

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This post was first published in November 2017.