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
Qualified 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While there are a few limited exceptions, for the most part there is a 10% penalty on any money withdrawn prior to 59½[1].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).
[1] Penalty Free 401(k), IRA Withdrawals, http://www.bankrate.com/finance/retirement/penalty-free-401-k-ira-withdrawals-1.aspx
[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/
[3] Forbes, 1/15/2013 http://www.forbes.com/sites/janetnovack/2013/01/15/11-ways-to-tap-retirement-cash-early-without-a-10-penalty
[4] Different types of plans have different provisions for penalty free withdrawals. 401(k)s generally speaking have more restrictions than IRAs.