401k plans are great savings vehicles for retirement. Many plans offer matches from employers and they all provide tax free growth of capital for account holders. While 401k’s are a really useful tool, they do have their limitations. Here are a few of the 401k withdrawal rules and 401k contribution limits.
401k Withdrawal Rules
Since your contributions to a 401k are from pre-tax income, there are limits governing the withdrawals for the plan. In general, 401(k) plans only allow withdrawals at or after the age of 59 ½. Also, you will be forced to take a distribution by the age of 70 ½ or you will be subject to a tax penalty from the government. The distribution that is taken is known as the required minimum distribution and must be in line with the guidelines of the IRS. Failing to take the minimum distribution amount can result in a whopping 50% penalty.
As with most things, there are exceptions. There are special situations in which withdrawals can be taken without having to pay the early withdrawal penalties, such as in the event of emergency situations such as becoming disabled. You can also avoid penalties if you use the money to pay for college expenses. A first time home purchase is considered an exempt transaction too. Keep in mind that you will still have to pay taxes on your early withdrawals since you didn’t pay taxes on your contributions.
401k Contribution Limits and Withdrawal Limits
401k contribution limits are very straight-forward. As of 2011, a person age 49 and below can legally contribute up to $16,500 a year. A person age 50 and above can contribute up to $22,000.
While the government does regulate the amount that can be contributed to the plan, there are no 401k withdrawal limits once you reach that magical age of 59 1/2. You can take out as much money as you like but you need to be prepared to deal with the financial consequences that may occur. Any withdrawals taken before 59 ½ are treated as non-qualified withdrawals and you will have to pay a 10% penalty to the federal government on top of the normal taxes. You can pretty easily create a plan that allows you to structure withdrawals so that you are taking the required minimum amount at the right age.
Even though there are no official withdrawal limits, I would suggest never withdrawing so much at once that you would be hindering yourself during retirement. Many people stick to the 4% rule or less. The thought process is that as long as you take 4% or less out every year, your total 401k should last you 25 years or more.
My Personal 401k Situation
My husband and I are attempting to save for retirement in multiple ways so that we will never be forced to take more than we want from any one savings plan. Theoretically, we should be able to balance the taxed withdrawals from my 401k along with non-taxed withdrawals from our Roth IRA’s in such a way as to stay in the lowest tax bracket in retirement. This method should also allow us to stretch all of our retirement accounts to cover nice, long lives.
What are your experiences with a 401k?