Reasons You Can Make Early Withdrawals From Your 401(k) Without Paying a Large Penalty

Your 401(k) plan is a tax-deferred investment account that allows your investments to grow tax-free until you withdraw money after you reach retirement age. Money you contribute to your plan comes from your pretax income, and generally you cannot withdraw it without paying a penalty until you reach 59-1/2 years of age. Under certain circumstances you may withdraw money early, but in most cases you will have to pay a penalty.          

Hardship Withdrawals

If your particular 401(k) plan allows for it, you can take a hardship withdrawal for certain circumstances spelled out in your plan's prospectus. Not all plans allow this, but if yours does, you may take an early withdrawal to pay for items such as funeral expenses, home repairs and education expenses. However, if you are not yet 59-1/2, you will be required to pay a 10 percent early withdrawal penalty even on hardship withdrawals unless you are taking your withdrawal because you have become disabled, or to cover medical expenses that exceed 7.5 percent of your income, or you have been terminated from your job and you are at least 55.

IRS Rule 72(t) Withdrawals

Anyone can take early withdrawals without penalty under Internal Revenue Service Rule 72(t). This rule allows you to take early annual distributions from your plan based on your life expectancy. Your life expectancy is determined based on actuarial tables used by the IRS. Bankrate.com and many other websites have calculators on their sites to help you figure the amount you can take out each year under this rule. If you opt for this plan, you must take the same amount out of your account each year and pay income taxes on it. Your withdrawals must continue for at least five years and you can't contribute to your plan during that time.

401(k) Loans

Many 401(k) plans allow you to take a penalty-free, tax-free loan from your account. In this case, you may borrow up to 50 percent of your account balance. As long as you pay back your loan on a timely basis with interest -- usually within five years -- you will not be penalized. If your investments are earning a higher return than the interest you pay back on your loan, it might be cheaper for you to seek a loan from a lender rather than use money in your 401(k).

Regular Distributions

Once you reach 59-1/2, the money in your 401(k) is yours for the taking. You can withdraw the entire amount of your account in one lump sum if you wish. Or you can take regular distribution payments each year. Either way, you won't have to pay any penalties on your withdrawals, but you will have to pay income taxes on anything you take out.

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