How to Remove the Tax Penalty on 401(k)
In most cases, you are not allowed to withdraw money from your 401k plan before you turn 59 1/2 years old without paying a 10 percent tax penalty. However, the Internal Revenue Service (IRS) allows exceptions to this rule that allows you to withdraw your money early without paying this penalty. These exceptions include suffering a permanent disability, paying unreimbursed medical expenses that exceed 7.5 percent of your adjusted gross income or leaving your job after age 55.
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Instructions
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Determine the amount you are qualified to withdraw penalty free. If you are claiming medical expenses, multiply your adjusted gross income by 0.0075 and subtract the result from your unreimbursed medical expenses. For example, if your adjusted gross income was $35,000 and your unreimbursed medical expenses were $6,000, you would subtract $262.50 to find you are eligible to withdraw $5,737.50 penalty free. If you are claiming a permanent disability or if you left your job after age 55, there is no limit.
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Gather documentation to support your withdrawal in case of an IRS audit. If you are claiming a permanent disability, a doctor's note documenting your condition is sufficient. If you are claiming medical expenses, you should have receipts or other documentation.
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Complete form 5329 to document your withdrawal and the reason it is qualified. On the space next to line two, write the code for your withdrawal. For example, if you were 56 and left your job, you would enter "01." A complete list of codes can be found online in the IRS instructions for form 5329.
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File your income tax return using form 1040 and attach your form 5329 to remove the penalty on your early withdrawal from a 401k.
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Tips & Warnings
If you work as a public safety employee you can take distributions from your 401k plan without paying the 10 percent penalty if you leave your job after age 50, rather than the 55 usually required.
Even if the penalty for an early withdrawal is waived, you may still be required to include the money as part of your taxable income. You will receive a form 1099-R at the end of the year that shows the taxable portion of the distribution in box 2a.
