Rules to Consider when Withdrawing Early from Your 401k

When withdrawing from your 401k account early, meaning before you are 59.5 years of age, you must consider a couple of penalties.  One is a 10% penalty which can only be waived if you are permanently disabled, you have a qualified retirement plan that will be deducting funds from the 401k, the holder of the account is now deceased, or you request periodic, equal, and substantially sized payments to span your lifetime or expected lifetime.  There will also be a 20% withholding tax mandated by the IRS that will be counted on your taxes for that year.  This 20% tax can never be avoided until you are at least 70.5 years of age.  To withdraw, you must take a lump sum from the provider of your 401k account who will write you a check less the 10% and 20% penalties.  If you are over 59.5 years of age but under 70.5 years, you can withdraw a lump sum from the provider less the 20% withholding tax.  The additional 10% penalty does not apply here.

If your 401k has more than 5,000 dollars in it, I would suggest that you leave it alone until such time that you can atleast avoid the 10% penalty.  You can also role over the sum into an individual IRA account or an individual 401K.  The individual 401k is for those who plan to start a one person business.  Rolling your funds over to any other account can be tricky and I would suggest that you hire a financial advisor to help you through the process.  In any event you will need to find a mutual fund broker or a discount brokerage firm to move the money to and manage the new account.

If you do choose to withdraw early from your 401k, you will always have to pay the 20% withholding tax.  It will be withdrawn from your total lump sum automatically.  You must, however, no longer be employed by the company through which you were provided the 401k.

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Posted on Dec 1, 2010