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Questions about 401k withdrawals with the 55 rule.

My husband is separating, and we are considering paying off our house with 401k funds, but also want to mitigate the tax hit. 1) Is there a time limit to withdraw funds? 2) Can you make multiple withdrawals from the plan, so long as it stays with your current employer? 3) Is your ability to withdraw from the plan cancelled if you obtain a new job or start your own business?

Aug 20, 2014 by Leslie from Dallas, TX in  |  Flag
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You are wise to consider the tax implications before withdrawing 401(k) assets! Far too many people try to fix it after the fact.

I'd like to clarify a few facts: (1) your husband is separating/separated from service with the provider of the 401(k) plan; (2) your husband will be age 55 or older in the year of separation; (3) your husbands 401(k) provider allows for partial withdrawals after separation from service.

If all these are true, you would be able to spread your withdrawals over multiple tax years to minimize the tax impact. There is generally no time limit, though this special "Age 55" rule is only valuable until age 59 1/2, at which point funds can be withdrawn with no early withdrawal penalty. This transaction should be permitted even if he starts a new job or business - just be sure to plan for the tax impact of his income plus the 401(k) withdrawal.

Best wishes,

Jeremy M. Shafer

1 Comment   |  Flag   |  Aug 20, 2014 from Midland, MI

The first two are true. The third we are still waiting to hear from his employer. This is exactly why we are asking these questions, especially about the time limit, because of the impact of taking the income this year. Thanks for the info!

Flag |  Aug 20, 2014 near Dallas, TX

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Hi Leslie,

Besides what Jeremy said, I want to add that any 401k withdrawals will be taxable (unless you had post-tax contributions or roth 401k contributions). The age 55 rule only waives the extra 10% penalty on early withdrawals.

I don't know your whole financial picture, but assuming you can afford the payments from your income, I suggest you do not pay off your mortgage. The outstanding mortgage is probably at a fairly low interest rate and the mortgage interest payments are tax deductible. In fact, depending on your tax situation, the mortgage interest might be allowing you to itemize your deductions and you need to analyze your taxes to see if you can itemize without the mortgage. The mortgage also gives you financial flexibility by allowing your 401k saving to continue to grow tax deferred. Maybe you CAN pay off your mortgage, but you need to really think about whether that is the best thing for you. A financial advisor can help you with this analysis.

1 Comment   |  Flag   |  Aug 20, 2014

We don't know our whole financial picture yet either, but currently he only has a prospect of replacing about 10% of the income. That could change, but the road is unclear. That is why we are trying to get these kinds of answers. Are they decisions we have to make right away or can we wait? (hence the time limit question). If the above job is the only one he has, lowering expenses will be important (hence does taking a job disqualify withdrawals.) I agree that a tax deduction is nice, but a little like having a baby for the tax deduction - the costs far exceed the financial benefit, so that is not really a factor in our decision. Appreciate the input.

Flag |  Aug 20, 2014 near Dallas, TX

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