Current tax law places a stiff penalty of 10% on Early Withdrawals From 401k retirement plans. Nevertheless, there are some special circumstances under which owners of 401k plans can withdraw or receive an early distribution from these funds without incurring any penalty at all.
These instances include buying a home for the first time, hardship cases, and using it to fund the expenses of getting a higher education.
The ideal situation is that these retirement plans are not touched until it is time to retire, but that is not always possible. Emergencies do occur, and at this time having a ready source of liquid funds to draw from can help get out of an otherwise disastrous time.
It was the Federal government that set in place pension plans like the 401k or IRA, and doing so has encouraged many families to start saving for the future.
Since the government is responsible for making it easier to save, it simply makes sense that it also does everything it can do to discourage the use of them until the designated time for retirement. It is also good that the same government recognizes that it sometimes becomes necessary to tap into those funds at critical junctures in life.
Applicable Rules For Early Withdrawals From 401k Plans
The 10% penalty for early withdrawal from 401k makes it more difficult for participants who wish to use the savings in these plans. This is particularly true for anyone that is below the age of 59.5 years.
Even though it may be harder to access these funds than it is with an ordinary savings account, there are some exceptions that will allow individuals to get the money they need without having to pay a heavy price so watch out for common mistakes. Funds can be withdrawn for the following reasons.
• Funds can be withdrawn to pay medical bills for yourself or family members.
• Withdrawing funds from a 401k for use as the down payment on a home is considered valid by the government.
• To prevent the foreclosure on a property such as a home.
• To use to pay college expenses for spouse or child.
While these reasons are considered acceptable by the government for early withdrawals from 401k accounts, rules state that after getting immediate accesses to these funds one cannot contribute to their plan again until 6 months have elapsed. There are other circumstances when the penalty can be waived, and some of these are listed below.
• Family can withdraw from 401k plans when the person holding it is deceased.
• If the plan holder has become permanently disabled.
• If the plan holder gets fired, resigns or retires.
• At 55 years of age.
• Once the employee starts making equal payments periodically after early withdrawals from 401k plans.
One must remember that there are limitations on annual contribution amounts, and while you can take advantage of catch-up provisions each year it is still not a good idea to take early withdrawals from your 401k or IRA accounts unnecessarily.
To learn more about traditional versus rollover IRA accounts, check out this post. For this reason, and because of the steep tax penalties, it is important to carefully consider all other possibilities prior to deciding to withdraw from 401k plans before retirement.