Circumvent Paying Fines on Your 401k Early Withdrawal

Millions of Americans that save money in their IRAs or qualified plans have no intention of withdrawing that money until after they reach age 59½ . However, unpredictable situations can force a person to go for a premature 401k withdrawal. Any number of misfortunes, such as medical expenses from an uninsured accident or an extended period of unemployment, can leave all other sources of liquid assets depleted.

One has to even use the last source - the retirement plan - when faced with a financial crisis. At all costs you would like to avoid the 10% 401k early withdrawal penalty inherent in any kind of premature distribution. However, the IRS has allowed for several exceptions to this rule over time, although the rules for traditional and Roth IRAs versus qualified plans differ somewhat.

Let us have a look at these exclusions from the penalty.

Conventional IRA

Demise of the owner - pre-age 59 1/2 beneficiaries may receive the account exempt from the penalty
Total and permanent disability of the account owner
Rule 72(t) (a sequence of lifetime substantially equal periodic payments)
Health expenses exceeding 7.5% of AGI
Qualified higher education expenses (for any of the immediate family)
Purchasing or constructing a home (if a home not owned in prior 2 years), up to $10,000
Payment of health insurance for the jobless

Roth IRA

For the Roth IRA, there are identical exemptions which are for the Conventional IRA (up to $10,000 withdrawal for those who are buying a home free from 10% tax provided the money has been in the Roth IRA for five tax years at least).

Qualified Plans

Those exemptions that apply to the conventional IRA also apply to this also.
If you depart from your employer at the age of 55 or later, you are qualified for this plan.
Distributions made to your ex-spouse due to a qualified domestic relations order (QDRO).
Payment allocation from Employee Stock Ownership Plans (ESOPs).

The main purpose of these exemptions, laid down by IRS, is to give relief and backup to financially challenged people. People who are most entitled to benefit from this are those suffering from grave circumstances such as death, divorce, and the disability; also individuals trying their best to excel in the field of education or working on building their home can receive help by getting penalty-free early 401k withdrawals.

If you are currently strapped for funds and would like to know if you are eligible to take a penalty-free distribution from your IRA or qualified plan, ask an accountant. The above list of exceptions has been simplified and additional conditions apply to get a penalty-exempt 401k early withdrawal.