Unemployment & 401(k) Withdrawals

All 401(k) withdrawals must be declared on your tax return.

When your employer sets up a 401(k) plan, you gain a tax-deferred retirement account. You may contribute money to the account; you do not declare these "elective deferrals" on your income tax return or pay tax on them until you withdraw the money. IRS rules govern how and when you may withdraw funds from the account. Under normal circumstances, you may not withdraw any money from the account until you reach the age of 59 1/2 years. Under certain hardship conditions, however, you may make early withdrawals. Sudden unemployment can bring these conditions about.

Hardship Withdrawal Limits

You may only make "hardship withdrawals" before the age of 59 1/2 in the original amount of your elective deferrals. In other words, you can only take out what you put in. You may not withdraw income or capital gains from the invested money.

Penalty on Early Withdrawal

Withdrawals made before the age of 59 1/2 are subject to a penalty of 10 percent, and are taxable. You must declare them on your tax return for the year in which you make the withdrawals.

Penalty-Free Withdrawals

The IRS does allow penalty-free withdrawals under certain specific circumstances. You still will have to pay income tax on the withdrawals, no matter the conditions of the withdrawal or your employment status. You may make a penalty-free withdrawal, for example, to buy a primary home -- one in which you reside -- or to avoid foreclosure or eviction from your primary home.

Tuition Expenses

If you are unemployed, you may be hard-pressed to afford college tuition for your kids. The IRS allows you to make an early, penalty-free withdrawal for college tuition for yourself or a dependent, but the tuition payment must be due within 12 months of the date you withdraw the money.

Unemployment

If you lose your job (through a layoff, termination, or resignation), or if you take early retirement at the age of 55 or above, then you may also take a penalty-free withdrawal from the 401(k). If you become unemployed at any age, you may also set up a regular withdrawal schedule, in which you take equal amount of money out of the 401(k) over your remaining years according to your life expectancy; you must continue the withdrawals for at least five years or until you reach 591/2 years old -- whichever is longer.

References

• IRS.gov: 401(k) Resource Guide - Plan Participants - General Distribution Rules
• Frontier: Unemployed? What to Do About Your 401k?
• Money-Zine.com: 401k Withdrawals