Federal Tax Penalty for Early 401k Withdrawal

If you cash out your 401k early, you may have to pay a stiff penalty.

401k plans are employer-sponsored retirement accounts that offer tax breaks for individuals. The money usually must be left in the account until retirement age of at least 59 1/2 to avoid early withdrawal penalties.

Time Frame

Once a person turns 59 1/2, she is eligible to start taking withdrawals from a 401k plan regardless of employment status. Exceptions include being able to take withdrawals if she becomes disabled or leaves her position after age 55 without paying a penalty.

Penalty

Non-qualified withdrawals from a 401k account are subject to a 10 percent penalty, and must be included as income on taxes during the year that a person takes the distribution.

Considerations

Before taking an early withdrawal from a 401k, see if you can use the 401k as collateral for a loan. As long as the loan is for less than half the value of the 401k value and does not exceed $50,000, it is not taxable.

Exceptions

For certain "immediate and heavy" financial burdens, the IRS allows people to withdraw 401k money early without penalty. These include home payments to purchase a home or prevent eviction, excessive medical costs and educational expenses.

Effects

The IRS penalizes early distributions to prevent people from taking advantage of the tax benefits 401k plans offer for anything besides retirement savings.

References

• IRS: 401k Resource Guide - Plan Participants
• IRS: 401k Resource Guide - Plan Sponsors