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Prepare to Pay a Penalty to Get Out of a 401(k) Early

In 2010 alone, Americans paid $5.8 Billion in penalties for early withdrawals from qualified plans according to IRS numbers

broke male pocketsQualified Plans (like 401(k)s and IRAs) were designed to facilitate saving for later or post-working years.  One of the key benefits is the deferral of taxes.  That’s the carrot.  The stick is a penalty structure that is particularly punitive if an individual wants to take their money (yes it’s their money…they earned it…who else’s could it possibly be?) out prior to age 59½.

While there are a few limited exceptions, for the most part there is a 10% penalty on any money withdrawn prior to 59½[1].  You also are responsible for all of the regular taxes due on the amount of the withdrawal, which could very well jump you into a higher tax bracket.  Additionally there is a 20% mandatory withholding on withdrawals so regardless of how much your actual tax liability is you can only access 80 cents on the dollar.[2]

In 2010 alone, Americans paid $5.8 Billion in penalties for early withdrawals from qualified plans according to the IRS[3].  This is in addition to the regular taxes owed on these withdrawals.

So you want to retire before you are 59 ½? Or you want to help put your children through college or start a business or maybe you lose your job and need the money just to eat?  If your money is sitting in a 401(k)[4], tough luck…you should have been better prepared…. (unless you want to pay the 10% penalty).


[2] Here’s a simple calculator from Wells Fargo.  Remember to use the new tax bracket the additional income would put you in  https://www.wellsfargo.com/investing/retirement/tools/401k-early-withdrawal-calculator/

[4] Different types of plans have different provisions for penalty free withdrawals. 401(k)s generally speaking have more restrictions than IRAs.

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