How to Determine Penalties for 401k Early Withdrawals

Sometimes in life emergencies arise where you find yourself in a cash crunch. If you don't have a reserve, the only place you may be able to get the money is from your 401k. However, before you yank the money, you should determine how much it is really costing you. You may be better of taking a home equity line or 0 percent credit card.

Difficulty:

Moderate

Instructions

1. Determine what federal tax rate you are paying. Once you take the money out of the 401k it is considered income. Because the withdrawal is from money that is pre-tax, it needs to be taxed. The federal income tax rate runs from roughly 15 percent to 35 percent for the majority of Americans. Check your previous tax return to find yours. Also, watch out that the withdrawal you are taking doesn't bump you into a new tax bracket.

2. Check the state income tax you paid the previous year. Unfortunately that amount of money needs to be removed as well.

3. Add 10 percent to the amount of the withdrawal you are making to get your final answer. For instance if you are taking $30,000 to buy a car and are in a 20 percent tax bracket in a state with 5 percent income tax, your $30,000 removal will only net you $20,000. You lose $3000 for the penalty, $6000 for the federal income tax and $1000 for the state income tax.

4. Check to make sure that you don't qualify for an exemption from the penalty. There are certain instances (like a terminal illness) where you can access your money early without the penalty.

Tips & Warnings

• You can also take a loan against your 401k for certain things. Loan money is usually limited to half the value of the 401k up to $50,000 with a timeframe of 5 years to repay the money. And you are paying the money back to yourself. You just may be able to avoid all of the penalties.

• Remember to adjust your budget if you are taking early withdrawals and incurring penalties. Save money in other places (like a personal IRA) to make up the difference.