Getting Money Early from Your 401(k)
Many people in their 20s and 30s balk at the idea of putting away a significant portion of their income in a retirement fund. Retirement is still 35 or 40 years down the road, and they fear that their money will be locked away somewhere, never to be seen until they leave work for the last time.
Often, your employer will let you borrow against your plan and will deduct the repayment from your paycheck. The money you repay goes right back into your account, and you pay yourself, not a bank, with the principal and interest. If your employer doesn't have such a loan program, you'll be unable to withdraw funds from the 401(k) unless you leave your employer. You'd have to change jobs in order to gain access to your funds, which seems harsh, but helps to guarantee that the funds are there when you retire. There are certain situations in which you may withdraw from your 401(k) for hardship, but you must demonstrate real need or hardship to your employer in order to be able to do so. There may be a lapse of several months between the time you leave a company and when the money in your 401(k) becomes available. This is due to the administrative work to calculate your share, its growth, and so on, by your employer's 401(k) administrator.
If you withdraw your 401(k) money before you're 59.5 years old, expect to pay some stiff penalties. You'll pay a 10 percent penalty, and the money will be taxable, which can be a significant blow at tax time. The IRS directs that people who withdraw funds from their 401(k) plans have 20 percent withheld from the money to be used for tax payment. The problem is, that amount usually isn't enough money to pay for both the penalty and the taxes owed on the withdrawal.
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A 403(b) plan is similar to a 401(k), except that it's offered only by hospitals, schools, and nonprofit employers. Assets from 403(b) plans normally are held with an insurance company in an annuity format. Participants can contribute up to 15 percent of their salary to an annual maximum of $13,000 in 2004. After that, the amount that participants can contribute will increase by $1,000 every year, up to a maximum contribution of $15,000 in 2008.
For example, if you withdrew $5,000 from your 401(k) plan and had the standard 20 percent withheld ($1,000), then you would receive $4,000. But if you were a taxpayer in the 27 percent bracket, you'd owe $1,350 in taxes, plus $500 for the penalty, for a total of $1,850. The 20 percent taken out wouldn't cover those costs, and you'd be $850 short on April 15. Not a nice surprise! Still, the 401(k) is your money, and you can get it if there is a real need, and if you're willing to pay the penalties. The 401(k) plans continue to gain popularity and are giving many people an incentive to start saving for retirement. One thing to watch for is this: Some employers make you wait a year until you can start contributing to a 401(k), so check with the company's benefits department if you have questions.
You may hear about vesting of funds when your employer discusses your 401(k). Vesting is the amount of time you are required to work for a company before you are entitled to the funds your employer has put into your retirement account on your behalf.
Cliff vesting (usually three years) means you must work for your employer for three years before you are entitled to the matching funds placed in your 401(k). If you change jobs after only two years and your company has three-year cliff vesting, then you will only have your own contributions available to move elsewhere. This portability is what makes 401(k)s so popular. If you leave this employer after three years, then you receive the employer's match as well as your own contributions.
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Vesting is the amount of time required for an employee to work for a company before he or she is entitled to the employer's contributions to the plan. There are two types of vesting: cliff and graduated.
When you are thinking of changing jobs, consider whether to change immediately or to wait a bit until you are vested. Always know how much of your retirement plan is employer-matched, and how much you have to lose if you leave.
The second way for an employer to vest is via graduated vesting. You are partially vested after two years, but you must stay with your employer for six years before you are 100 percent vested. The schedule goes as follows:
|Years Employed||Percent Vested|
When you change jobs, whether you are vested or not, you have your contribution to your 401(k). These funds can be withdrawn (but let's remember income tax liability and penalty), rolled over into an IRA, or even possibly rolled over into your new employer's 401(k) plan.
If your new employer has a 401(k) plan, then see if you can transfer directly from a former employer's 401(k) plan to your current employer. If you can't, roll the funds into a separate IRA, and then roll it into your new 401(k) later, if permitted.
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Excerpted from The Complete Idiot's Guide to Personal Finance in your 20s and 30s © 2005 by Susan Shelly and Sarah Young Fisher. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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