If you withdraw money from your 401(k) plan before you reach age 59½, you may have to pay an early withdrawal penalty. The penalty is 10% of the amount you withdraw, and it’s in addition to any income taxes you may owe. There are some exceptions to the early withdrawal penalty, such as if you withdraw the money to pay for certain medical expenses, college tuition, or a first-time home purchase. However, it’s important to understand the rules before you withdraw money from your 401(k), so you can avoid any unnecessary penalties.
Avoiding the 10% Penalty on Your 401(k)
If you are planning to retire early, you may need to tap into your 401(k) or other taxable investment accounts while you are still in the pre-retirement stage (generally prior to age 59½). However, if you take your 401(k) distribution before you reach the age of 59½, you could face an extra 10% tax on your distribution as an early withdrawal fee (penalty).
Exceptions to the 10% Penalty
There are a number of narrow “exceptions” to avoid the 10% additional tax if you take a distribution while you are still working but over the age of 59½. Some of the most common ones are below:
- Disability – You can avoid the 10% early distribution fee if you are considered “totally and permanently” by the IRS due to a condition that prevents you from doing any type of work you are “reasonably” able to do.
- First-time home purchase – You can avoid the 10% fee if you use up to $10,000 (lifetime limit) of your taxable account early distribution to help pay for the purchase of your first home.
- Qualified higher education costs – You can avoid the 10% fee if you use the money to pay for your college costs or your child or certain other family member’s college costs.
- Medical emergency – You can avoid the 10% fee if you use the money to pay for uncovered medical costs that are more than 7.5% of your income.
- Loan from your 401(k) – You can avoid the 10% fee if you take a loan from your 401(k) instead of taking a distribution (see the IRS website for specific rules).
If You Are Still Penalized
If you do have to pay the 10% fee, you will need to include the amount of the distribution that is subject to the fee on line 4a of Form 1040, and the amount of the fee on line 4b. You will need to complete Form 8606 to calculate the tax due.
| What is Taxed | Payment Deadline | |
|---|---|---|
| Federal Taxes | All income, including money made from all taxable investment accounts (less related “above the line” and other adjustments) | April 15th for the prior tax year (or generally by January 23rd with a paid preparer) |
| State Taxes | Most states have a personal income tax – some only tax interest and dividends | Typically due in April 15th |
Exceptions to the Penalty
Early withdrawal penalties do not always apply to withdrawals from 401k accounts. There are certain exceptions that can allow you to withdraw money without having to pay the 10% penalty. These exceptions include:
1. Disability: If you become disabled and unable to work, you may be able to withdraw money from your 401k account without paying the penalty.
2. Medical expenses: You can withdraw money from your 401k account to pay for qualified medical expenses without paying the penalty.
3. Higher education expenses: You can withdraw money from your 401k account to pay for qualified higher education expenses without paying the penalty.
4. First-time home purchase: You can withdraw up to $10,000 from your 401k account to purchase a first home without paying the penalty.
5. Substantially equal periodic payments: If you withdraw money from your 401k account in substantially equal periodic payments over your lifetime, you may be able to avoid the penalty.
In addition to these exceptions, there are also certain circumstances in which the penalty may be waived. For example, if you withdraw money from your 401k account to pay for expenses related to a natural disaster, the penalty may be waived.
If you are considering withdrawing money from your 401k account, it is important to speak to a financial advisor to determine if you qualify for any of the exceptions or waivers. Withdrawing money from your 401k account before age 59½ can have a significant impact on your retirement savings, so it is important to weigh all of your options before making a decision.
Calculating the Penalty
The early withdrawal penalty for 401(k) plans is 10%. This means that if you withdraw money from your 401(k) before you reach age 59½, you will have to pay a 10% penalty on the amount you withdraw. In addition, you will have to pay income taxes on the amount you withdraw.
For example, if you withdraw $10,000 from your 401(k) before you reach age 59½, you will have to pay a $1,000 penalty. In addition, you will have to pay income taxes on the $10,000 you withdraw.
There are some exceptions to the early withdrawal penalty. You can avoid the penalty if you:
- Withdraw money to pay for qualified medical expenses
- Withdraw money to pay for qualified education expenses
- Withdraw money to pay for qualified first-time homebuyer expenses
- Withdraw money to pay for certain other expenses, such as disability or death
If you are not sure whether you qualify for an exception to the early withdrawal penalty, you should speak to a financial advisor.
Avoiding Early Withdrawal Penalty
Unless you want to pay an additional 10% of your withdrawal as an early withdrawal penalty tax, you should avoid withdrawing funds from your 401(k) before reaching the age of 59½. This penalty is in addition to any income tax you may owe on the withdrawal. You may also have to pay state income tax on the withdrawal.
There are a few exceptions to the early withdrawal penalty. You can withdraw funds from your 401(k) without penalty if you:
- Are over 59½ years old.
- Are disabled.
- Are taking withdrawals to pay for certain medical expenses.
- Are taking withdrawals to pay for higher education expenses.
- Are taking hardship withdrawals.
If you are not sure whether you qualify for an exception to the early withdrawal penalty, you should consult with a tax advisor.
If you do not qualify for an exception to the early withdrawal penalty, you can still withdraw funds from your 401(k) before reaching the age of 59½. However, you will have to pay the 10% early withdrawal penalty. The penalty will be withheld from your withdrawal, so you will receive less money than you expected.
| Age | Penalty |
|---|---|
| Under 59½ | 10% |
| 59½ or older | 0% |
Alright, folks, that’s a wrap on early withdrawal penalties from your 401k. I hope this article cleared up any confusion and helped you understand the potential consequences of taking money out early. Remember, it’s always better to plan ahead and avoid dipping into your retirement savings if possible. Thanks for hanging out with me today. Be sure to check back soon for more financial wisdom and insights. Take care!