IRA stands for individual retirement account. Traditional IRAs can be opened and managed by account holders without the oversight of their employer. 401k plans must be initiated by the company. These two plans have different account rules that govern when withdrawals can be taken and which withdrawals are subject to the 10 percent early withdrawal penalty.
When Can Money Be Distributed?
IRAs and 401k plans differ greatly as to when money can be withdrawn from the account. IRAs permit withdrawals at any time, for any reason, even though those withdrawals may be subject to taxes and penalties.The distribution rules for 401k plans make the account much more illiquid, meaning it can be very difficult to remove the money. You may only take money out of the 401k plan if you are over 59 1/2, leave your job, suffer a permanent disability or have a financial hardship. A financial hardship only occurs when you have no other financial resources, such as money to avoid eviction from your primary residence.
Which Withdrawals are Penalty-Free?
The IRS does not impose an early withdrawal penalty on withdrawals from a traditional IRA taken after the account holder reaches age 59 1/2. However, the IRS also waives the early withdrawal penalty for IRAs if the account holder uses the money for medical expenses exceeding 7.5 percent of the adjusted gross income, higher education costs, up to $10,000 for a first-time home purchase or if you suffer a permanent disability. For 401k plans, withdrawals can be taken penalty-free after the account holder turns 59 1/2, if the withdrawal is taken for a permanent disability or if the withdrawal after the employee leaves employment after turning 55. Hardship withdrawals are subject to early withdrawal penalties.
Reporting Withdrawals on Taxes
Both traditional IRA distributions and 401k distributions must be included in the account holder's taxable income for the year. To do this, taxpayers must use either form 1040 or form 1040A to file their taxes. If a withdrawal occurs before age 59 1/2 from either an IRA or 401k plan, the taxpayer must file form 5329 to either document the reason for not paying the 10 percent early withdrawal penalty or to calculate the amount of the penalty. If a taxpayer owes a penalty, it must be reported using form 1040.
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