Many employers offer you the option of putting money from your paychecks into a 401k fund. 401k funds collect investment income over the years and allow tax-deferred savings toward retirement. However, if you withdraw retirement funds before you reach retirement age, you must pay taxes, and in many cases, penalties, even if you are laid off from your job.
Penalty Free Withdrawals
Generally you must be over the age of 59 1/2 to qualify for penalty-free withdrawals from your 401k. You may face tax penalties if you withdraw funds when you are less than this age, even if you are no longer working for a particular employer. If you withdraw your funds early, your plan provider must withhold 20 percent of your funds toward taxes and withhold an additional 10 percent of your funds as a tax penalty.
The IRS provides some exceptions to the tax penalty for early withdrawal of funds. If you die, your heirs have the right to withdraw funds from your retirement account. In addition, if you become totally and permanently disabled, meaning you cannot work anymore due to physical or mental disability, you can withdraw funds from your 401k even if you are younger than 59 1/2 years. You may also be able to withdraw funds without penalty if you have medical expenses in excess of 7.5 percent of your income or retired after the age of 55 but before the age of 59 1/2, if that is allowed under your plan. However, while the 10 percent penalty does not apply, your distribution will be taxed as regular income.
Distribution After Leaving Job
If you have less than $5,000 in your 401k when you leave a particular job, you can keep it in your retirement account. However, if you have more than $5,000 in your account, your former plan sponsor is usually required to distribute it to you. If you are under the age of 59 1/2 years, your plan sponsor must withhold a 20 percent penalty in this circumstance. You may roll over your funds into an IRA to avoid this penalty and immediate income tax liability.
Once you reach the age of 70 1/2 years, your 401k provider must distribute funds to you if you have retired. If you are still working, some providers may allow you to continue to keep all your funds in the account, while other providers may, as a matter of policy, distribute a certain amount of your funds to you each calendar year. If you are retired, you must receive either your entire account balance or a certain amount per year once you reach this age.