401(K) Withdrawals

Your Guide to State, Local, Federal, Estate + International Taxation

A 401(K) is a type of retirement plan established by employers that permits employees to defer part of their salary on a pretax basis. Early withdrawals from a 401(k) plan or IRA accounts are subject to a 10% penalty prior to reaching age 59½. A Roth 401(k) works in a similar manner but the deferrals are funded with after-tax dollars.

The basic concept of the 401(k) plan is to save money slowly over time and allow it to build up for retirement savings. However, there are times when you may need to tap into those savings. To dissuade participants from doing this before retiring, the IRS imposes a ten percent early withdraw penalty. However, there are some exceptions and the early withdrawal penalty may not apply to the following situations:

  • The participant’s death
  • The participant becomes disabled
  • The participant incurs a hardship and the participant is over age 59 ½ (the plan must allow for it and the plan may have certain stipulations)
  • Distributions to a qualified reservist that is called to active duty (period in excess of 179 days)
  • Use the money to pay for federal income taxes as a result of a levy on the specific retirement plan
  • Use the money to pay for unreimbursed medical bills that exceed 7.5% of your Adjusted Gross Income (AGI) (The medical expenses must be incurred in the same year as the distribution)
  • Payments made to prevent eviction from your residence or foreclosure on your residence
  • Plan loans (You can borrow money from the 401(k) plan and arrange to repay the money over a certain period of time including interest)

The IRS allows you a penalty free withdrawal for distributions from an IRA but not from a 401(k) for first-time home buyers and you can receive a distribution for acquisition costs. You can qualify if you have not owned a home during the two years prior to the date of buying the home. However, if your 401(k) plan allows it, you can roll the money over to an IRA from your 401(k) and then withdraw the funds from the IRA to use the exception.

All of these types of withdrawals are subject to the most common tax argument, “it depends”. If you are planning on making one of these distributions, contact your plan administrator to see if your plan allows the distribution and what consequences it will create.

By Kelsey Olsen