401k Penalties

As with most corporate retirement plans there are early withdrawal penalties for 401k plans. In general, there are withdrawal penalties for withdrawing on a 401k plan before the age of 59 and a half. An individual must pay the taxes at their ordinary income tax rate plus a 10% penalty. When withdrawing on a 401k plan, 20% is withheld automatically for tax purposes when the withdrawal is requested. When factoring in state taxes, the total tax and penalty can often be as high as 40%. All options should be carefully considered before taking a withdrawal and the corresponding 401k early withdrawal penalty. Often times a home equity line of credit or low interest rate credit card may be better options.

A 401k withdrawal can occur in two different situations. The first situation occurs when there is a financial hardship. In this case, the withdrawal must be necessary due to an urgent and significant financial need and money may not be available from any other sources. Before this withdrawal can occur, an individual must have taken out all loans available in the 401k plan. A financial hardship withdrawal can occur to purchase a primary residence, to prevent foreclosure of a primary residence, to pay for tuition for yourself/spouse/dependent, or to pay for unreimbursed medical expenses. Please note that ordinary income taxes and the 10% penalty still apply for hardship withdrawals. There are also withdrawals that are not subject to the 10% early withdrawal penalty. These include permanent disability, medical debts that exceed 7.5% of adjusted gross income, court orders for a divorced spouse/dependant, stoppage of work (laid off, quit, early retirement) the year one turns 55 or later, and the 72(T) regulations which allows an a person to take equal installments for the rest of their life. The 72(T) payments must last for a minimum of 5 years or until one reaches ages 59 and half, whichever is later. Please note that ordinary income taxes still apply but the 10% penalty does not.

Taking a withdrawal on a 401k plan can lead to substantial taxes and penalties. At Clay Northam Wealth Management, we can help you analyze all of your options before deciding to pay the early withdrawals penalty associated with a 401k early withdrawal. There is a balance between the needs of today and the need to prepare properly for retirement. Feel free to contact our offices in El Segundo and Seal Beach with any concerns regarding 401k withdrawals and penalties.

Note: This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.