How to Calculate 401K Early Withdrawal Penalties

Many companies provide 401K retirement plans to employees using a "Plan Document". This document is the guide that authorizes the employers to allow contributions, distributions and investments in a 401k plan. The plan has to be authorized by the IRS and must comply with IRS tax rules.


Generally, if you are under 59 ½ years old early withdrawals from a 401K are tax penalized. There are exceptions to these rules; the "Plan" may allow some types of early distributions with no penalties. To qualify for these exceptions you have to read the company's 401K plan or discuss your situation with your Human Resources staff. Use these tips to help you calculate 401K early withdrawal penalties and evaluate other alternatives.

Instructions

1. Tax Liabilities

   Understand the payments due for early 401k withdrawal. There are two payment components for early withdrawal: The first one is the tax bill on the distribution's income for federal and state. The second is the tax penalty required by most plans.

2. Federal Tax Due

   Determine your federal income tax rate to calculate 401K early withdrawal tax due. The total amount of the distribution you take out is taxed at your federal tax rate. For example taking out $10,000 from your plan will leave you with a tax bill of $2,800 if your rate is 28%, assuming that the distribution is all income.

3. 

   State Tax Due

   Estimate your State income tax bill on the 401K withdrawal. If your state income tax rate is 8%, you will owe $800.00 to the state on the $10,000 distribution, assuming all is income again.

4. Tax Penalty

   Start calculating 401k early withdrawal penalty. IRS rules generally require that the plan charge a 10% tax penalty for early withdrawal, unless you qualify for an exception. This is in addition to the income tax due for early withdrawal. In our example this penalty is equal to $1000.00.

5. Options to 401K Early Withdrawal

   Consider other options to early 401K withdrawals. Because the taxes and the penalties can be high depending on the amount of the withdrawal and on your tax rates, consider taking a 401k loan instead. Loans are given at very favorable interest rates and the interest goes into your 401k account.

   Find out if your 401k early withdrawal qualifies for one of the government exceptions before taking a distribution. Read your plan guidelines or discuss with a Human Resources staff.

Tips & Warnings

• Visit the IRS website for additional information on 401k early withdrawal penalties and tax rates.

• Read your 401k plan guidelines for early withdrawal penalties