A 401k retirement plan has many advantages such as tax advantage, investment customization and flexibility, employer match programs, portability, and loan and hardship withdrawals. However if funds in the account are retrieved or distributed prior to age of 59.5, a 401k tax penalty of up to 10% can apply. There are seven exceptions for early distribution penalty: the plan participant is permanently disabled or dies, plan participant retires, quit or is terminated and is over the age of 55, distribution is a part of “substantially equal payments” based upon your life expectancy, participant incurs medical expenses which surpass 7.5% of adjusted gross income, distribution is mandated by a court in divorce proceedings, certain distributions to qualified military reservists called to active duty.You can also face a 401k tax penalty during a “rollover” of funds between two different retirement plans. This can occur if you get a new job, which has a different retirement plan than the one that you have already been a part of. A rollover can be directly done into another eligible retirement account. The aforementioned option prevents the 20% mandatory income tax withholding. A distribution paid to you will have a mandatory income tax withholding of 20% regardless whether you intend to roll it over later. You have 60 days from the date of distribution to roll a retirement plan over. The IRS wants 401k plan participants to save money for retirement, therefore the government needs to be sure that during a rollover the money goes into another qualifying retirement plan.There are many different 401k plans, and just as many rules. Understand your 401k rules to avoid 401k tax penalty. Before making withdrawals or transactions that can be perceived as withdrawals, consider talking to your plan administrator.
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