You've worked hard to save through your 401k, but saving is only half of the equation. When and how to take distributions are an underappreciated part of the story.

Most people just simply take distributions out of the 401k. However, please be aware that it will be treated as ordinary income, and if you are not age 59 ½ or older yet, it will also incur a 10% federal penalty.

-Foundation for Financial Wellness

Video Transcript:

OK, so the most common form of retirement savings in this country happens inside of our 401k accounts. So, the first question is normally, “So, how can I use the money from my 401k?”

You basically have three options. Most people just simply take distributions out of the 401k.  However, please be aware that it will be treated as ordinary income, and if you are not age 59 ½ or older yet, it will also incur a 10% federal penalty.

The other two options for distribution – They’re a little more complex, so let’s talk about those now. (IRS rule 55 and IRS Regulation 72(t))

IRS Rule 55 is a little-known gem to people aged 55 or older. If you are 55 or older, you have a one-time opportunity to take a distribution. It will be taxed as ordinary income, but it will not be subjected to the 10% federal penalty.

Many people will tell you that this is a great way to take money out of your 401(k), but it is an irrevocable decision that has long-term significant tax consequences. So, make sure that you are well-prepared and well-informed before doing that. Under IRS Regulation 72(t), you elect to take substantially equal payments under the latter of reaching age 59 ½ or five years. So, these distributions will be taxed as ordinary income again but will not incur the 10% federal penalty. You should think it out carefully. It’s not a magic bullet by any stretch, but it could be a strategy worth considering.

So let’s do a quick review here for you to decide at this point do you have any decisions to make or actions to take.

What might be the most tax efficient and retirement-planning-friendly way for you to take income from your 401k. Is it a traditional distribution, an IRS Rule 55, or an IRS Reg. 72(t)?

If you don’t know, then the action to take from this lesson may be to reach out and schedule a call with a tax or financial professional. Or as always, don’t forget. You can take advantage of your private counseling session. It’s included. It’s private and confidential, and it’s always with one of our Certified Financial Wellness Counselors. To schedule your counseling session, simply click on the “Request Counseling” button.