401(k) Withdrawals – Early Withdrawal Penalties, Rollover Withdrawals, Exceptions and Tax Consequences

(July 1st, 2009)

The purpose of 401(k) retirement plans is to encourage people to save for their retirement years and not rely on the country’s broken social security and pension system. Therefore, it is the responsibility of the government to impose rules and regulations that discourage withdrawal of funds from 401(k) retirement accounts. In this article, we explore the various rules encompassing 401k withdrawals, penalties involved, exceptions that may apply to you as well as tax consequences of 401(k) withdrawals.

Early 401(k) Withdrawals

Early 401k withdrawal is defined as any withdrawal from your 401(k) plan before the age of 59 and ½ years. This early 401k withdrawal is not limited only to 401(k) plans but also other plans including:
- An Individual Retirement Account (IRA) excluding educational IRAs
- Qualified employee annuity plans
- 403(b) plans for public school employees, etc.

Most premature or early 401(k) withdrawals have to be reported as income on your tax return. Not only this, you will also have to pay a 10% early withdrawal penalty on the funds you have withdrawn. Notice how harsh and cruel the IRS is with early 401(k) withdrawals, the reason being they want to discourage you from withdrawing money from your retirement account because you will need this money the most when you stop working and have no additional sources of income, other than your retirement nest egg. The government is also telling us to stop relying on social security, as the benefits from it are not secured.

401(k) Rollover Withdrawals and Distributions

There are no penalties charged on 401(k) funds withdrawn that you intend to rollover to another qualified retirement plan such as an IRA or 403(b) plan. This is because that money is still serving its recommended purpose, retirement nest egg. A 401(k) rollover is defined as when you withdraw cash, stocks, bonds or mutual fund shares from one qualified 401(k) plan to move to another qualified retirement plan, traditional IRA or a Roth IRA within 60 days.

Exceptions for 401(k) Early Withdrawal Penalty

You can avoid the 10% early withdrawal penalty on funds withdrawn prematurely from 401(k) plans if your withdrawal meets one of the following five criteria. These are known as ‘allowable 401(k) distributions.’ They are: