If you contribute to an employer sponsored 401(k) plan you probably already know that there is a 10% IRS penalty if you withdraw funds from that plan prior to age 59 ½. (1)
This means if you withdraw $10,000 from your 401(k) plan before age 59 ½ you will have to pay the IRS a $1,000 penalty (10% of $10,000) in addition to standard income taxes.
Here is an example of how that would look if you withhold 20% federal taxes and 5% state taxes (income tax always must be paid, regardless of age).
Withdraw Amount: $10,000
Federal Taxes: $2,000
State Taxes: $500
10% Penalty: $1,000
Amount You Receive: $6,500
However, there are exceptions to the rule. The 10% IRS penalty will not apply, if distributions before age 59 ½ are made, in any of the following circumstances:
Made to a beneficiary on or after the death of the participant.
Made because the participant has a qualifying disability.
Made as part of a series of substantially equal periodic payments beginning after separation from the service and made at least annually for the life expectancy of the participant or the joint life expectancy of the participant and his/her beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59 ½, whichever is the longer period.)
Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55.
Made to an alternate payee under a qualified domestic relations order (QDRO).
Made to a participant for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the participant itemizes deductions)
Made on account of certain disasters for which IRS relief has been granted.
One other way to gain access to your 401(k) funds is to take a loan. Some 401(k) plans permit participant to borrow from the plan. The plan document must specify if loans are permitted. A loan from your employer’s 401(k) plan is not taxable if it meets the following criteria. Generally, if permitted by your plan, you may borrow up to 50% of your vested account balance up to a maximum of $50,000. The loan must be repaid within 5 years, unless the loan is used to buy your main home. The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan.
For more information about 401(k) distribution rules visit www.IRS.gov.
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