A 401(k) is a retirement plan, in which you can save for retirement and defer income taxes on this saved money. A portion of your wages is deposited into this 401(k) account. Usually these plans are sponsored by your employer, and the investment might include a combination of the following: mutual funds, stocks or bonds. The point of the 401(k) is to give you some security once you retire. However, there are stringent guidelines that govern what and when you can use this money.
The majority of employers have restrictions upon removing the money while you are still under their employment and under the age of 59 and a half. However, there are certain ways around this withdrawal issue, and most companies acknowledge that money can be withdrawn under certain circumstances. These circumstances usually include: if you need to pay significant medical bills for you or for your family, if you need to put money down to purchase a house (but not for the individual mortgage payments), if you are paying for your child’s college education and if your home is about to be foreclosed. If you withdraw for these reasons, it’s considering a “401(k) hardship withdrawal.”
Once you turn 70 and a half, or on April 1st of the calendar year after you retire, you can begin to make distributions from your 401(k) account according to IRS tables. The amount of the distributions that you can make is entirely based upon your life expectancy. However, there are different rules if you are still working once you’ve reached the allowed age. If you are still working, the minimum distributions that you are allowed to make differ from the IRS table.
There are also numerous tax rules associated with your 401(k) and retirement. Any amount of income which you defer into this account, you do not have to pay federal income tax on. Further, any earnings on the investments of your 401(k) are not subject to taxes. This is especially significant if you consider the possibility of compound interest that your 401(k) could earn after years of investments. When you begin to make withdrawals, however, your withdrawals on money from your 401K are normally taxed as ordinary income.