hero image

As one advance in age, their 401(k) accounts grow in value, and it can be tempting to spend their hard-earned savings. It is generally easy to get money into the 401(k) saving plan but much harder to get the money out. The funds are available to pensioners upon attaining the age of 59½ years old. Withdrawing a 401(k) before the required age could lead to additional penalties. If one does not proceed with care, they may end up paying a steep price.

You may need to access your 401(k) savings to get college tuition for your kids, a downpayment for a new house, or just a financial emergency. You need to proceed with care to minimize early withdrawal penalties.

Consequences of a 401(k) early withdrawal

One of the advantages of a 401(k) plan is that the contributions are tax-deductible. In addition, one also grows in terms of tax-deferred. The contributions help reduce one’s deductible income and reduce the total amount they pay in taxes. In addition, you are exempted from paying taxes on earnings and contributions until distribution. However, these tax benefits are only applicable if you operate within the terms and conditions of the plan, as laid out by The Internal Revenue Service. Before are consequences of an early 401(k) withdrawal:

  • Taxes will be withheld. In general, a 401(k) early withdrawal attracts 20% of the withdrawal in taxes. Traditional 401(k) withdrawals are taxed just like ordinary income. However, a 401(k) early withdrawal attracts income tax on the amount you withdraw.
  • Penalties from IRS. A 401(k) early withdrawal will attract a 10% penalty by the IRS. However, there are additional rules that allow for penalty-free hardship withdrawals. For instance, employees who are fired laid off, or quit their job between 55 and 59 ½ of age are exempted from 401(k) early withdrawal penalties.
  • Reduces the amount available for the future. You may lose your income if you make the early withdrawal when the market is down. Money in retirement accounts earns a return on investment with time. Removing the funds invested means the account holder can no longer access these returns.