Withdrawing from 401k Accounts without Tax Penalties

You will be penalized for withdrawing from a 401k prior to reaching retirement age in most situations. In general, the rule is enforced because the IRS designs tax benefits for these accounts in order to encourage saving for retirement. If you do not use the accounts for that reason, you will have to surrender the tax benefits and more. There are very rare exceptions to this rule, but there are times you can avoid the penalty.

401k Loans 

You can take a loan from your 401k if your company permits this option. You will have to repay the loan within a short period in order to avoid tax penalties, and you cannot use the loan sum to invest in an income-producing asset. There are two exceptions to this policy. The IRS allows you to withdraw money from your 401k to pay for secondary education for yourself or your children without tax penalties. You may also use the money to place a down payment on your first home. Any time you take a loan or withdraw money from your 401k outside of these scenarios, you will face a 10 percent penalty in addition to your tax obligation.

Hardship Withdrawals

It is a misconception that hardship withdrawals are not penalized. You have the option of withdrawing from your 401k account at most companies if you are experiencing an extreme hardship. This can include a layoff, disability or illness. However, 401k accounts are not designed to be emergency savings accounts. Therefore, if you take the money out to use as emergency savings and do not replace it within a short period, you will have to pay the 10 percent tax. This means that if you cannot repay the money, you actually have to take 10 percent more than you need out of your retirement account in order to pay for your emergency expenses.

401k Rollovers

If you have a 401k with a specific company but want to move the savings into another plan, you are permitted to do so. Once funds are fully vested in your account, they are yours to move about as you please. However, whenever you roll over your funds into a different account, you should be aware of strict rules. The rollover must take place within a narrow window of time, and it is usually best to arrange for a direct rollover to avoid penalties in the case of a delay. If the money comes to you first and then goes into a retirement account, you may owe a penalty if you hold onto the money for too long.

Loan Against a 401k

If you want to avoid a penalty, consider using your savings as collateral for a loan. You do not have to take the money out of your 401k account. Instead, you can simply allow a lender to place a lien on a portion of your retirement account in exchange for issuing you a loan. When you repay the loan, the lien goes away. The only time the funds would need to be withdrawn would be if you could not afford to repay your debt.