Individual Retirement Accounts
 

401k Early Withdrawal

When you withdraw money from your 401k before you retire, you are taking a 401k early withdrawal. 401k withdrawals are taxed as ordinary income but a 401k early withdrawal is not only taxed as ordinary income but it also carries a 10% early withdrawal penalty.

401k Early Withdrawal

If possibly, you should not take a 401k early withdrawal because assets in 401k plans accumulate tax deferred which means you don't have to pay tax on your 401k contributions until you withdraw. When you withdraw, you are taxes at your income tax bracket.

The more asset you have in your 401k the more money you accumulate fast. If you make a 401k early withdrawal, you forego the tax deferral benefits, have to pay the early withdrawal penalty and it will be hard to put more money back in your 401k or other retirement accounts because of the yearly 401k limit or other retirement plan's limit. If you have an IRA, the contribution limit is very low and it will take a long time to get back where you were with your 401k before you took a 401k early withdrawal.

Exceptions to the 401k early withdrawal penalty

Fortunately there are times when you will not have to pay the penalty on 401k early withdrawals. Below are the situations where you will be exempt from having to pay 401k early withdrawal penalty.

  • The 401k early withdrawal is made upon the death or disability of the plan participant.
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  • You were age 55 or over and you retired or left your job when you made the 401k early withdrawal.
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  • You received the 401k withdrawals as part of "substantially equal payments" over your lifetime or 72t distribution.
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  • You take a 401k early withdrawal and paid for medical expenses exceeding 7.5% of your adjusted gross income.
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  • The 401k distributions were required by a divorce decree or separation agreement.