Information on tax and penalties for 401K early withdrawal - The Bills.com Blog
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Information on tax and penalties for 401K early withdrawal
Question: If I withdraw my 401k and give it to my spouse as a gift, would I still face a very steep tax penalty?
Answer: In general, if you withdraw money from a traditional individual retirement account such as a 401(k) or other qualified retirement plan before you turn age 59 1/2, you are subject to penalty of 10%. The taxable amount is also included in your taxable income. This 10%tax is in addition to regular income taxes. Please note that the associated penalties and taxes are applied at the time of your withdrawal transaction, so even if you plan to gift the proceeds later on, you will still be liable for the penalties and applicable taxes.
You can avoid this additional tax penalty if you meet certain criteria, but you cannot avoid including your retirement withdrawal from your taxable income. Some withdrawals can be made without penalty, but these usually require a true financial hardship.
Here is more information about hardship based withdrawals.
Two types of hardship withdrawals are permitted from 401k plans. One is called a financial hardship withdrawal. It is subject to applicable income taxes and a
10 percent early withdrawal penalty if you are younger than 59 1/2. The other is a penalty-free withdrawal made under Section 72(t) of the Internal Revenue Code. With this, you pay applicable income taxes but not an early withdrawal penalty.
Financial hardship withdrawals are allowed for the following reasons:
* To buy a primary residence
* To prevent foreclosure or eviction from your home
* To pay college tuition for yourself or a dependent, provided the tuition is due within the next 12 months
* To pay un-reimbursed medical expenses for you or your dependents
You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:
* You become totally disabled.
* You are in debt for medical expenses
that exceed 7.5 percent of your adjusted gross income.
* You are required by court order to give the money to your divorced spouse, a child, or a dependent.
* You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
* You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)
I hope the information provided helps you Find. Learn. Save.
Best,
Bill
www.bills.com
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1. Posted by Kerry Ross on Tuesday 15th January 2008 16:11
Am I to understand the exception listed in this post, that if I retire early at age 55, separating from my employer,I can take a penalty free withdrawal from my 401k, and only pay income taxes on the amount withdrawn?
2. Posted by Nithin on Tuesday 15th January 2008 17:31
The withdrawal is penalty free "only" if you meet the stringent conditions for a hardship criteria that are detailed in the article.
3. Posted by Dwight Cranford on Friday 18th January 2008 15:25
I'm 59 yrs old. I have been laid off from my job. I have enough funds in my 401k to pay off my home loan. Is is possible to avoid early withdrawl pen. due to loss of employment.
4. Posted by Newman on Friday 18th January 2008 17:49
You will have to check with your plan administrator to see if your hardship does indeed qualify for withdrawal without a penalty.
5. Posted by Lynda Tolley on Monday 28th January 2008 21:18
My husband has a 401k plan in which he withdrew enough to get by in 2007. Would he be able to claim hardships and avoid the 10% penalty due to my medical costs and to help pay the rent, where we live? Can he claim a combination of the two? He retired from his job October,2006 at the age of 52. Thanks
6. Posted by Ray on Tuesday 29th January 2008 07:58
You will have to check with your plan administrator. Usually any withdrawal before the age of 59 1/2 is subject to the penalty. The criteria for hardships tend to be very stringently enforced, so I cannot really say whether you would qualify or not, just based upon the information you have given me.
7. Posted by Jennifer on Monday 11th February 2008 07:31
Hi, I am 35 yrs old and have been unemployed for a year now. I am still looking for a job, but very difficult to to multiple health issues (severe chronic daily pain which I have had for years now and also, more recently, suffered broken pelvis bone and after that broken ankle). Have tried to find "work from home" without success. We (husband and I) have gone through our entire savings and more in order to meet bills/mortgage etc..over last year. Now out of money again. My question is, I am forced to take a full withdrawal from my 401K plan (from previous employer). I'm sure I have to pay the 20% for fed taxes, but is there anyway I can claim exemption from the 10% penalty? I read your article, and know personally that I definitely have a true financial/health hardship, but don't know what specific exemption rule (if any) I could qulaify under. Thanks.
8. Posted by Nithin on Monday 11th February 2008 11:44
Jennifer, the specificity of the rules is dependent on what the IRS will accept. You will need to speak to your plan administrator about your situation. They will in turn check to see if your hardship would qualify.
9. Posted by Sue Valentine on Saturday 1st March 2008 12:46
On a 401k hardships do I have to have something from the company saying its a hardship? My 1009R just says that it is a distribution code 1. Does this mean that I'm still subjected to the penalties and do I still claim the taxable amount on my taxes ? Thanks for your imput. Sue
10. Posted by Bill on Monday 3rd March 2008 16:03
You will need to speak to your plan administrator and provide them with the information pertaining to your hardship. Your plan administrator would then check with the IRS rules, to see if your hardship qualifies for you to make a penalty free withdrawal. As far as the 1009R is concerned, it would be best for you to consult with your tax attorney to clarify the same.
11. Posted by Michael Fogarty on Monday 14th April 2008 14:57
I have been recently moved from long term disability status to drawing social security,as a result of a stroke that occurred in Dec 2005. Must I wait untill 59 1/2 to make a 401K withdrawal without penalty for early withdrawal?
12. Posted by Bills on Monday 14th April 2008 17:57
Michael, I suggest that you contact your plan administrator. The fact that you need to make this withdrawal because of a medical hardship might qualify for penalty free withdrawal. Only your plan administrator will be able to tell you if your hardship qualifies or not.