The rules for 401ks and IRAs are largely similar. There are, however, some important differences. For individuals between 55 and 59½, one difference can eliminate tax penalties for withdrawing funds before 59½.
Anyone leaving employment after the age of 55 may be eligible to tap funds from a 401k without tax penalty. For non-Roth sources, taxes must be paid as ordinary income, but non-penalty access is available four and a half years earlier.
There are two important notes in implementing this option. The age of 55 means by December 31 of the year in which you turn 55. If your birthday is in November and you leave employment the February before your 55th birthday, you can tap into the money while only 54.
If you leave employment before 55 – the year in which you turn 54 or earlier – you cannot tap into the 401k of the previous employer by aging into the gap period. The actual separation must come during the 55 to 59½ gap period.
Many people reflexively roll any former employer 401k into an IRA with each job change. While there are many cases where this move makes sense, there are also cases where it does not. In this example, anyone who leaves a company during this gap period has effectively received an emergency fund that can be tapped, if needed.
Depending on the employment prospects, goals, and overall financial picture of the individual, this may or may not be an important considerations in a keep-or-roll decision. Discussing issues such as this with an experience tax advisor can help you make a decision that is best for your given circumstance. Please contact us for help.