 |
 |
.jpg) |
401 K Withdrawal Policies and Penalties
The concept behind the 401K retirement account is that by encouraging employees to save via pre-tax deductions that you are going to continue to invest in your retirement until the day you retire. With this in mind the IRS has established a ten percent 401K withdrawal penalty on any monies that are taken out of the account prior to age 59 1/2.
This penalty is assessed no matter what the reason for withdrawal including financial hardships. There is only one exception to this by the IRS and that is if the amount withdrawn does not exceed the maximum amount allowed under Internal Revenue Code 213 and is to be used to pay for medical expenses that occur in the same taxable year.
Do Employers Penalize for Early 401 K Withdrawals?
You will find that almost all employers have very strict restrictions in place to discourage employees from withdrawing money from their 401K account. In most cases employers are going to ignore any hardship claims, including those that are approved under the appropriate IRS codes. In most cases the only way you are going to be able to take money out of your 401K account will be to leave your job. Any money that you do take out of your 401K will be subject to standard income taxes.
A large part of the reason for these policies is that the laws governing the tax-deferred status of the 401K require that other than very specific exceptions any money invested in this way must remain within this plan or an equivalent tax deferred retirement plan until you attain age 59 1/2, at which point you can withdraw your money without paying the ten percent excise tax on top of income taxes.
Exceptions to the Penalty for Early 401K Withdrawal
As stated there are exceptions to the rules governing penalties for early 401K withdrawal. These are very few but, include the death of the contributing employee, if the employee should fall victim to a total disability that is deemed to be permanent and if he should lose his job during or after the year he turns 55. Under IRS code sections 72t and 72q covering substantially equal periodic payments, also referred to as SEPP, the ten percent penalty may be waved under certain very specific conditions.
Another major exception to this ruling is a QDRO or Qualified Domestic Relations Order issued by a court of law. Typically these are issued in the case of a divorce or separation that will split up the ownership of the 401K. This is done to ensure that the spouse will receive their fair share of the monies that have been set aside for their retirement years.
When Must a Person Start Making 401K Withdrawals
With all of the penalties for early withdrawal, the next question is when can I start taking money out of my 401K account? Known as distributions, you can start taking them any time after you reach age 59 1/2 without having to pay the ten percent excise tax penalty. Remember however, that the longer you continue to contribute into your account, the more money you will have to retire on.
Any distributions that you take out after age 59 1/2 will be subjected to your current income tax rate and added to your total annual income, which could in effect raise your tax liability significantly. This is of course dependent on you income at that point and the size of the distribution you decide to take out during the taxable year.
Is there a Point at which I Must Start Making 401K Withdrawals?
According to the current IRS regulations in place there is a rule in place governing when you must start taking minimum distributions from your 401K retirement account. You are required to start taking these distributions starting no later than the first day of April in the year you turn 70 1/2 or by the first day of April one year after you retire, this is based on whichever of these dates is the latter of the two.
The only real exception to this particular 401K withdrawal rule is if you are still working when you reach age 70 1/2 and it only applies to any plan that you are actively contributing to at that time. Should you fail to take this required minimum distribution (RMD); the IRS will apply their most severe penalty, which is 50% of the RMD that you should have taken. The intent of the 401K is to encourage you to save for your retirement and the penalties are in place to help ensure that you do so, be very careful and think very carefully about making any kind of early withdrawal as the penalties are high.