What Is the Penalty for Cashing in a 401(k) Early?

The IRS tries to prevent people from using the tax advantages of a 401k account for purposes other than retirement savings by imposing a penalty if you cash in the account early. For the purposes of the IRS, the retirement age is 59 1/2.

Penalty

The penalty for an early withdrawal is 10 percent of the withdrawal on top of any taxes you may owe. For example, if you withdrew $10,000 early from a traditional 401k, you would have to pay a $1,000 penalty and include the $10,000 in your taxable income.

Filing a Penalty on Taxes

If you withdraw money early from your 401k, you must file a Form 5329 to determine your penalty and attach the form to your tax return. Your taxes must be filed using form 1040.

Exceptions

If you qualify for a hardship withdrawal or an exception--such as medical expenses exceeding 7.5 percent of your adjusted gross income, or permanent disability--you still need to file form 5329 but you can claim part or all of your withdrawal as being exempt from the penalty.

Income Taxes

Whether you need to include the withdrawal as part of your income depends on the type of 401k plan you own. Traditional 401k distributions must be included as taxable income while Roth 401k distributions are not taxable.

401k Exceptions

A distribution from a 401k plan is not considered an early distribution if you left the company after age 55, or if you are required to take a distribution that must be transferred to an alternate recipient under a court order, such as after a divorce.

References

• IRS Tax Topics: Topic 424 - 401(k) Plans
• 401k Withdrawals
• Form 5329