To prevent people from abusing the tax benefits of 401(k) plans for money they don't intend to use for their golden years, the Internal Revenue Service imposes a 10 percent additional tax on early withdrawals. Generally, any distribution taken before age 59 1/2 counts as an early withdrawal and is hit with a 10 percent early withdrawal penalty. However, the IRS does allow for several exception that let you escape the early withdrawal penalty, but not the income taxes, on distributions before you turn 59 1/2.
Reduced Age for Retirees
If you leave your company after you turn 55 years old, you can take out as much as you want from your 401(k) plan without paying any penalties. If you worked as a public safety employee for a state or local government, the news is even better: You just need to be at least 50 when you retire for the exception to apply. However, if you leave your job before hitting the required age, you'll be penalized on any withdrawals you take before you reach 59 1/2. For example, say you leave your company at 54. If you take a withdrawal at 56, the exception doesn't apply.
You can also take out as much as you want from your 401(k) if you're totally and permanently disabled, regardless of your age. To be considered disabled, you must have proof, such as a determination by a doctor, that you can't do any substantial gainful activity and that your condition will last for a long time or indefinitely.
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Series of Substantially Equal Payments
You can also avoid the early withdrawal penalty if your distribution is part of a series of substantially equal payments calculated based on your life expectancy; the younger you are, the smaller the distributions must be each year. However, you must continue the payments every year for at least five years or until you turn 59 1/2 years old, whichever is longer. If you modify the payments, you owe the early withdrawal penalty plus interest on all the prior years you used the substantially equal payments exception.
The IRS also has a few exceptions that apply to a limited amount of withdrawals. For example, if your medical expenses exceed 10 percent of your adjusted gross income, you can take out an amount equal to the excess without a penalty. You're also allowed to take out money if your 401(k) plan is levied by the IRS or if you have a qualified domestic relations order that requires you to transfer some of your 401(k) to your ex-spouse. You can't, however, take out money from your 401(k) to pay a property settlement during a divorce unless it's specifically required.
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