Your 401k is a tax-sheltered plan intended to help you save money for retirement. These plans have strict rules that prevent you from contributing more than the amounts specified by the Internal Revenue Service. Early withdrawals from a 401k are not allowed, although there are several exceptions. You will be penalized for making an early withdrawal that isn't covered by one of the exceptions.
You generally must keep money in your 401k until you reach age 59 1/2. If you withdraw money before this, you must pay regular income taxes on the amount you withdraw, as well as a 10 percent penalty. If you are subject to a penalty, this penalty is calculated on IRS Form 5329.
The IRS provides several exceptions to the 10 percent penalty on early withdrawals. These include using the money to pay for tax-deductible medical expenses, or meeting the conditions of a court order requiring you to split your 401k plan with your ex-spouse. If you are at least age 55 when you are terminated or quit your job, no penalty applies if you withdraw funds.
Another exception is withdrawing contributions made under automatic enrollment provisions of a 401k, if you withdraw the money within 90 days of your enrollment.
You also can elect to make penalty-free early distributions under IRS rule 72(t), which allows you to liquidate your 401k plan over the rest of your life, or to at least age 59 1/2. In addition, there is no penalty for early withdrawals when your 401k is passed to your beneficiary after your death.
If you need to use the money from your 401k and the purpose doesn't meet one of the exceptions allowed, you can take a loan from your account -- if your plan permits loans. To avoid a penalty on a 401k loan, you must repay the loan within five years, and you may only borrow up to 50 percent of your vested account balance. This 50 percent must not exceed $50,000.
The 10 percent penalty and ordinary income tax apply if you fail to repay the loan within five years, or if you leave your job and don't repay the loan in full.
When you leave your job, you may withdraw your 401k account balance without penalty, even if you are under 55. If the money is transferred directly from your 401k to an IRA or to a 401k at your new employer, no tax is due. However, if your 401k money is given directly to you, your plan administrator must withhold 20 percent for taxes. If you fail to deposit, or roll over, this distribution into an IRA or a new 401k plan within 60 days, you must pay the 10 percent penalty if you are under age 59 1/2. At any age, you must pay ordinary income tax on a distribution that is not rolled over.
Don't withdraw money from your 401k unless absolutely necessary, even if you qualify for a penalty-free withdrawal. Your 401k is part of your retirement savings strategy and withdrawing money from the plan means you have less invested for your future.