Quick Facts About the 401k Penalty
Most people who have a 401k plan know that they will by hit with a 401k penalty if they should withdraw their money early. Unfortunately, there are difficult times when life circumstances may mean taking the 401k penalty because the money is needed, and this is especially true during the tough economy we are experiencing today. This should be an absolute last resort, however, when there is no other option. We have put together some details and facts about what to expect when withdrawing a 401k early.
What is the 401k?
First things first. The 401k is a type of retirement savings plan. In fact, it is the most common way people today are saving for their retirements. A 401k plan cannot be opened independently. Rather it is offered by your employer, and they deduct money directly from your paycheck to put into the 401k. Many companies contribute money on your behalf to their employees’ 401k plans as an extra benefit, as long as the employee is contributing money as well. If your company has a 401k savings plan, sign up for it as soon as you can. It is a great way to save money for retirement, and the earlier you start, the more cash you will wind up with in the end.
What is a 401k penalty?
Because the 401k is essentially a retirement savings plan, it is untaxed savings. As such, there are certain restrictions placed on withdrawal of the funds contained in a 401k account. Since this is a long-term savings plan designed especially for retirement, there are no taxes taken out when money is deposited into the 401k. That means that if any of that money is withdrawn from the 401k account early, taxes must be paid on the funds that are removed.
The 401k account was created by the government as a way to encourage people to save money for retirement. Through the 401k, money is deposited and invested by your employer. Usually the employee can choose how and where they want their money invested, for example: 50 percent in company stock and 50 percent in another stock or market fund. By doing this, the 401k funds begin to earn interest and investment income so the money actually grows over the years. (That’s why it is a good idea to sign up for a 401k retirement account early. The earlier the 401k account is open, the more money it has a chance to earn for the account holder.)
How can I avoid paying a 401k penalty?
The best way to avoid paying a penalty on your 401k account is to leave the money in the account until the age of 59. That is the magic age for 401k withdrawal. Any funds that have been saved in a 401k retirement account can be accessed with no penalty, as long as the recipient has reached age 59.
There are a few instances when 401k money can be withdrawn early without a penalty, but they are extreme situations and must be proven.
> If you have a large medical bill that must be paid.
> If your home is about to go into foreclosure.
> If the funds are required to purchase a first home.
> To pay for the burial or a family member.
> To pay for an approved secondary education.
Of course, all of these examples have restrictions and must be approved, so check with the IRS before withdrawing your 401k money to make sure there will not be a penalty attached to any withdrawal of 401k funds.