How Does a 401k Penalize Withdrawals?

Borrow from the Plan and You May Pay Penalties

Avoid the penalties by paying back the loan. When you borrow from your 401-k, you have to make payments back with interest that goes right to your plan. There are no penalties or taxes when you borrow, but if you quit the job before you pay it back, you have to pay it back all at once or take both taxes and penalty on the loan when you file your taxes. The 401k doesn't penalize you, but the IRS does.

Don't Take More Than the Hardship

Avoid penalties with a hardship withdrawal, but don't take more than you need. The federal government says that you can take a hardship withdrawal from your 401k if you need the money for yours or a family member's college education, tax-deductible, non-reimbursed medical bills or need to prevent eviction or foreclosure on your home and can't get the money anywhere else. If you take more than the hardship need, then you get a penalty from the government when you file your taxes.

Don't Take the Money to Roll Over Later

Roll the money directly to a rollover IRA. You need to provide an account number and use a special form. If you ask the 401k administrator to make the check to you, they have to withhold 20 percent according to the law. When you roll the money into an IRA, you have to replace the money they sent to the IRS as withholding or pay taxes and penalties on it when you pay your taxes.

Beware of a Lump Sum

Take equal periodic payments if you need an income from the 401k money. The payments must last until you're 59 1/2 or at least 5 years if you're close to that age. This is one way to avoid the tax penalty from any qualified plan like the 401k or an IRA.

Remove the Money Without Penalties.

Take the funds from your 401k if you're disabled, have a court decree from a divorce that shows you must, quit your job and are over 55 or have medical bills that amount to more than 7.5 percent of your adjusted gross income. You may have to show proof. Remember, the penalty comes from the IRS when you pay your taxes, not from the 401k. The administrator of the plan sends in a form at the end of the year to the IRS that explains the withdrawal.