If you want to withdraw from your 401k early, then you need to know how to minimize 401k taxes. 401k plan is design to be a long term saving plan for your retirement, but in the case where you need to withdraw earlier than you suppose to, you will be penalized with an additional 10% early withdraw tax. However, there are exceptions to every rule, this one is not different. This will help you explore your way to minimize 401k taxes.
- Understand that 401k taxes should not be there the first place. Your 401k is a great way for you to defer tax as long as possible. You will not be taxed while contributing to your 401k. In many ways, you are deferring tax to the future, where you will pay ordinary income tax for your withdraw once you are 59 ½.
- It is a long term saving plan, so keep it that way. 401k is designed to be a long term saving plan for your retirement. While it is not taxable while you are contributing to it, but there is a caveat. If you want to withdraw early, you have to pay a 10% penalty tax. The best way to minimize that 10% penalty tax is to not withdraw your nest egg until 59 ½.
- If you have to withdraw early, then keep it minimal. The best way to minimize 401k taxes and income taxes is to keep your withdraw at the lowest level possible; preferably, during your lowest income year as well.
- Borrow from your 401k temporarily. If you need money in a hurry, but you will have sufficient money to replace the withdraw fund in 60 days. Then you can consider taking a 401k loan. Your withdraw amount will not be taxed if you can repay your 401k back in 60 days.
Tip: There are numerous exceptions to avoid the 10% early withdraw penalty from 401k. Please consult with the IRS website for more detail.
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