A 401k is an employer-sponsored retirement savings plan. Many companies offer 401k plans as an extra incentive for their employees, especially if the company matches part or all of the contributions. 401k plans offer tax breaks for contributions and tax-sheltered growth while the money remains in the account. However, the Internal Revenue Service strictly regulates when money can be taken out of a 401k.
When you turn 59½, you can start taking withdrawals from your 401k retirement plan without any penalty or restriction. In addition, if you retire after turning 55, you can take out money from your 401k plan without penalty. Other circumstances that allow you to withdraw money from your 401k plan early without penalty are distributions to pay for medical expenses that are over 7.5 percent of your adjusted gross income, or if you become permanently disabled. If you go through a divorce and are ordered to split your 401k with your former spouse, the withdrawal is not penalized.
Required Minimum Withdrawals
When you turn 70½, you must start taking required minimum distributions from your 401k plan. Even though these distributions are required, you must still report the amount of the distribution as taxable income. The size of the required minimum distribution is determined by dividing the value of your 401k plan by the time period the IRS expects the account to be distributed over. If you fail to withdraw the required amount, you must pay a 50 percent penalty on the amount you failed to withdraw. For example, if you were supposed to take out $24,000 and you took out only $9,000, you would pay a $7,500 penalty (50 percent of $15,000).
The IRS permits people to withdraw money from the 401k plan in the event of a financial hardship. Financial hardships are needs that cannot be satisfied by any other financial resource, such as money to avoid a foreclosure or funeral expenses. When you take a hardship withdrawal, you must pay a 10 percent penalty on top of the income taxes you will owe on the withdrawal. However, be warned that 401k plans have different sets of rules about hardship withdrawals. Even though hardship withdrawals are permitted under the IRS rules, they are not required, so not all plans offer them.