If your company offer the option to invest in a 401k plan they often provide you with a “Plan Document”. The “Plan Document” is the guide that permits your employer to appropriate investments, contributions, and distributions from your 401k plan.
Your company’s 401k plan must be authorized by the IRS, as well as abide by with the tax rules and regulations set forth by the IRS. 401k plans, and other accounts earmarked for retirement are designed for you to take distributions when you retire, and there can be severe financial consequences for early withdrawals.
There are times in life when the unexpected happens, and you may find yourself in need of funds quickly. The only source of money if you do not have a reserve fund may be your 401k account. There are several important considerations you should make before withdrawing the funds, as there are additional factors in calculating 401k early withdrawal penalties.
If you own an individual 401k through an online brokerage such as ETrade, or another financial institution, contact your plan’s provider for additional rules and stipulations.
Calculating 401k Early Withdrawal Penalties: Tax Liabilities
It is critical that you are fully aware of the payments required for an early withdrawal from your 401k. You will be expected to make two payments on your withdrawal, the first being a federal and state tax on distribution income, and the second is the required additional tax penalty found in most plans.
When calculating 401k early withdrawal penalties you must first find out your federal income tax rate. Your total distribution is taxed according to your federal tax rate. As an example, assuming that the distribution is all income and your tax rate is 25%, your tax bill would be $2,500 on a withdrawal of $10,000.
You need to then estimate your state tax rate, to figure out what state taxes will be due on your 401k withdrawal. Assuming that your state income tax rate is 6%, you will have to pay $600 in state taxes on a withdrawal of $10,000, once again presuming the entire withdrawal is income.
The next step is calculating the early withdrawal penalty, which are usually 10% per IRS rules, unless you can meet the conditions for an exception to this penalty. On a withdrawal of $10,000, the 10% penalty will total $1,000.
Calculating 401k Early Withdrawal Penalties: Other Options
As you can see from calculating 401k early withdrawal penalties, these taxes and fees can quickly add up, and that does not include earnings lost from compounding interest on the account.
While the initial tax bill may be staggering, you will never truly know the cost of losing the potential gains on your investments. Provided you make the maximum yearly contribution, this amount lost could total hundreds of thousands of dollars!
Consider other possible avenues for capital, including unsecured loans and even taking out a loan against your 401k. While borrowing from your 401k account is also not ideal, it can be considerably financially better that making an outright withdrawal from your retirement account.
Consult with a trusted financial adviser, such as the retirement account experts at ETrade, or your plan’s administrator to better find out what avenue is right for you.
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