Withdrawing funds from a 401(k) retirement account before reaching age 59½ typically incurs a 10% early withdrawal penalty, paid to the Internal Revenue Service (IRS). This penalty is imposed on top of any applicable income tax on the money you withdraw. Therefore, taking money out of your 401(k) account before retirement can significantly reduce your savings. Withdrawals made after turning 59½ are exempt from the penalty, but you may still owe taxes on the amount withdrawn.
Penalty for Withdrawing from a 401k Plan
Withdrawals from a traditional 401k plan before you reach the age of 59 1/2 are subject to a 10% early withdrawal tax in addition to any applicable income tax. This means that in addition to paying taxes on the amount you withdrew, you will also owe a 10% tax to the IRS.
Exceptions to the 10% Tax
There are a few exceptions to the 10% tax on early withdrawals from a 401k plan. These include:
* Hardship distributions: Withdrawals made to cover certain essential living needs, including health costs, education, or a first-time home purchase.
* Rollovers to another plan: Withdrawals made for the purpose of moving your 401k balance to another tax-advantaged account, such as an IRA or another 401k plan.
* Withdrawals after age 59 1/2: Withholdings are not subject to a 10% tax for any reason after you turn 59 1/2.
Penalty for Not Repaying a 401k Loan
If you take a loan from your 401k plan and fail to repay it on time, the amount of the loan you fail to repay will be considered an early distribution and will be subject to the 10% tax plus any applicable income tax.
Taxes on 401k Distributions
In addition to the 10% early withdrawal tax, you will also owe income tax on any funds you withhold from your 401k plan. The amount of income tax you owe will depend on your tax bracket.
The following table shows the tax bracket percentages for federal income taxes in 2023:
| Tax Bracket | Marginal Tax Rat} | Tax Amount on $1 of Taxable income |
|—|—|:-:|
| 10% | 10% | Up to $10,275|
| 12% | 12% | $10,275 to $41,775|
| 22% | 22% | $41,775 to $89,075 |
| 24% | 24% | $89,075 to $117,850 |
| 26% | 26% | $117,850 to $160,925 |
| 28% | 28% | $160,925 to $210,450 |
| 30% | 30% | $210,450 to $265,725 |
| 32% | 32% | $265,725 to $414,700 |
| 35% | 35% | $414,700 to $622,050 |
| 37% | 37% | $622,050 to $1,022,600 |
| 39.6% | 39.6% | Over $1,022,600 |
Example
Let’s say you are in a 22% tax bracket and you withhold $10,000 from your 401k plan early. You will owe $100 in early withdrawal taxes, plus $2,200 in income taxes, for a total of $2,300.
Early Withdrawal Fees
Withdrawing money from your 401(k) before age 59½ generally incurs a 10% early withdrawal penalty, in addition to any applicable income taxes. Here’s a breakdown of the fees and penalties:
Income Taxes
- Withdrawn funds are taxed as ordinary income at your current tax rate.
- Federal withholding tax of 20% may apply if you do not provide a Form W-4-P to waive withholding.
10% Early Withdrawal Penalty
The 10% penalty applies to withdrawals made before age 59½, unless you meet certain exceptions (see below).
Exceptions to Early Withdrawal Penalty
| Exception | Conditions |
|---|---|
| Substantially Equal Periodic Payments (SEPP) | Withdrawals taken as equal payments over at least five years or until age 59½ |
| Disability | Withdrawal is made while you are disabled |
| Death | Withdrawal by the beneficiary of a deceased account holder |
| Qualified Higher Education Expenses | Withdrawal is used to pay for qualified education expenses of the account holder, spouse, or dependents |
| First-Time Home Purchase | Withdrawal of up to $10,000 (lifetime limit) for a down payment on a first home |
| Unreimbursed Medical Expenses | Withdrawal is used to pay for medical expenses that exceed 7.5% of your adjusted gross income |
Reduced Retirement Savings
Withdrawing money from your 401(k) early can have a significant impact on your retirement savings. The amount you withdraw will be taxed as income, and you’ll also have to pay a 10% penalty if you’re under the age of 59½. This can add up to a hefty chunk of money, especially if you withdraw a large amount.
For example, if you withdraw $10,000 from your 401(k) at age 45, you’ll have to pay $1,000 in taxes and $1,000 in penalties. That’s a total of $2,000 that you’ll lose from your retirement savings.
The following table shows how much you’ll have to pay in taxes and penalties if you withdraw money from your 401(k) early:
| Withdrawal amount | Taxes | Penalties |
|---|---|---|
| $10,000 | $1,000 | $1,000 |
| $20,000 | $2,000 | $2,000 |
| $30,000 | $3,000 | $3,000 |
As you can see, the taxes and penalties for withdrawing money from your 401(k) early can be substantial. It’s important to weigh the pros and cons carefully before making a decision.
Potential Tax Increase on Future Withdrawals
Withdrawing from your 401(k) before the age of 59 1/2 may result in a 10% early withdrawal penalty on the amount withdrawn. Additionally, if you are under the age of 55, you may be subject to additional income tax on the amount withdrawn.
The following table provides an overview of the potential tax implications of withdrawing from your 401(k) early:
| Age | Tax Penalty | Additional Income Tax |
|---|---|---|
| Under 55 | 10% | Yes |
| 55–59 1/2 | 10% | No |
| 59 1/2 or older | 0% | No |
- The 10% early withdrawal penalty is applied to the amount withdrawn, not the earnings on the amount withdrawn.
- The additional income tax is calculated based on your tax bracket at the time of withdrawal.
- If you withdraw money from a traditional 401(k), the amount withdrawn will be subject to ordinary income tax.
- If you withdraw money from a Roth 401(k), the amount withdrawn will be tax-free as long as you have held the account for at least five years and you are at least 59 1/2 years old.
Thanks for sticking with me through this overview of the penalties for withdrawing from your 401(k) early. I know it’s not the most exciting topic, but it’s imperative to be informed about the potential consequences before you make any decisions. As always, consult with a financial advisor if you have specific questions about your situation. In the meantime, keep checking back for more articles on personal finances, retirement planning, and other topics that can help you make informed decisions about your money. Catch you next time!