Taxpayers must always pay income taxes on 401(k) withdrawals as saving money for retirement is critical, and taking advantage of accounts created for that purpose has advantages.
However, the most common types of retirement plans have convoluted requirements that may make it difficult to access your money. For example, if you withdraw money at an early age, you may face tax penalties. Continue reading to learn about the most tax-efficient ways to withdraw funds from your account.
How To Avoid Penalty For Early 401(k) Withdrawals?
There are ways to lower penalty from early 401(k)withdrawals, according to Miles Brooks, certified public accountant and CoinLedger’s director of tax strategy.
The same is true for traditional IRAs: if you take money from them before reaching the age of 59 1/2, there is a 10% early withdrawal penalty, which is in addition to the income tax you would incur. When you reach the age of 55, you can take penalty-free 401(k) withdrawals if you leave the job associated with that account. (or later).
Read more: Social Security reminds what to do if you don’t have 40 credits
Avoid Distributing Twice In The Same Year
Your first RMD is due by April 1 of the year after your 73rd birthday. Every year, you must take your second distribution, as well as any following ones, before December 31.
If you wait until April to take your first distribution, you’ll have to take two in the same year, which could result in an exceptionally high tax payment – or perhaps put you into a higher tax band.
Make sure to calculate whether taking your first and second RMDs in separate tax years may minimize your tax burden.
401(k) Rollover Without Tax Withholding
When you shift employment and take money from your 401(k), withhold 20% for taxes. If you do not deposit the entire payout, including the 20% withheld, into a new retirement account, you may incur income tax as well as the early withdrawal penalty on the amount withdrawn.
However, if you move the money straight from your 401(k) to the trustee of another 401(k) or IRA, you can avoid the tax withholding and the potential for penalties and costs. When you conduct a trustee-to-trustee transfer, you are not required to withhold tax.
Read more: Student loan programs that may help you to erase your debt; Here’s how!