IRS Penalties for a 401K Withdrawal
Many employers offer their workers 401k plans to help them save for retirement, and often will make matching contributions to these accounts. Employee contributions are made with pretax dollars and the money grows tax-free in the 401k account. The IRS imposes penalties on non-qualified withdrawals from 401k plans. In order to take a qualified withdrawal and avoid penalties, you must wait to access the money until you are 59 1/2 years old, or you leave the company after turning 55.
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Early Withdrawal Penalty
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Early withdrawals, also known as early distributions, from a 401k plan are subject to a 10 percent tax penalty on the amount of the withdrawal. Early distributions occur if you withdraw money from your 401k plan when you leave your job before reaching retirement age, but do not redeposit it in a qualified retirement account within a specified period of time. The IRS does not impose any penalties on successful rollovers. 401k plans permit withdrawals in the event of financial hardships such as needing money to pay for higher educational expenses or to avoid being evicted. However, the 10 percent tax penalty is not waived in these circumstances. Permanent disability, medical expenses exceeding 7.5 percent of your adjusted gross income, or distributions due to an IRS levy on the account are the only exceptions to penalties.
Federal Income Taxes
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In addition to penalties, you must also pay income taxes on the amount of the withdrawal. The amount of the withdrawal is included as regular income and will be taxed at whatever tax bracket you fall into for the year. However, if the amount of the withdrawal pushes you into a higher tax bracket, you will pay that higher tax rate. For example, for 2010, if you make $82,400 and are single, you fall into the 25 percent tax bracket. However, if you increase your taxable income with a 401k distribution, you would be pushed into the 28 percent tax bracket.
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Limiting Future Contributions
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When you take an early withdrawal from your 401k plan, the IRS prohibits you from making a contribution to that 401k plan for at least six months after the withdrawal. Depending on when you withdrew the funds, this rule can cause you to miss out on making your annual contribution and receiving matching contributions from your employer. In addition, you are not allowed to make a larger contribution in future years to make up for the money that you took out.
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References
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