Is there a 401k early withdrawal penalty?

A lot of people get tempted to withdraw money from their 401k plans prior to retirement for a variety of reasons. Before you consider making an early withdrawal from your 401k account, you should think twice: early distributions will not only leave you with a considerably lower retirement income, but will also entail a 10 percent penalty tax on the amount withdrawn.

The early withdrawal penalty applies to any distributions made before the 401k participant has reached age 59 ½. The 10 percent tax is imposed on the distributed taxable amount.

401k Early Withdrawal Penalty Exemptions

The 10 percent early withdrawal tax does not apply in the following cases:

• If the participant in a 401k dies (in the event of this happening, the beneficiary receives the funds);
• If the employee becomes disabled;
• The employee leaves the respective job after reaching age 55;
• The payments are made to a payee under a qualified domestic relations order;
• The distributions are used to pay outstanding medical liabilities which are deductible under the IRS;
• The participant has separated from service and has started receiving the distribution in equal regular installments paid at least every year. There are certain requirements that have to be met for this exception to be applied: the distributions must continue for a minimum of five years or until the employee turns 59.5, whichever is longer);
• 401k distributions are made in order to reduce employee contributions and employer matching contributions, which would otherwise be in excess;
• The distribution from a 401k plan is made in order to lower an employee's excess elective deferrals.

Bear in mind that the 10 percent early withdrawal penalty applies to any kind of premature withdrawal from a 401k plan, even if it is for reasons of hardship. However, the loan provision that exists in 401k plans makes it possible for 401k participants to borrow money without a penalty, in the form of a loan.

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