Regulations Regarding 401k Early Withdrawal

401k is a retirement savings plan that is regulated by the government. The government discourages people from withdrawing money from their accounts before retirement. Therefore certain regulations have been put in place that make people think twice before tapping into their retirement fund. Normal distributions made after an individual has turned 59 1/2 years of age are normally taxed at prevalent tax rates. However, if a person is in extreme need of these retirement funds before the due date then they should do so only after carefully weighing the pros and cons.

Withdrawals made before a person reaches 59 1/2 years of age are called early withdrawals. These withdrawals are generally penalized by the federal government at the rate of 10%. It is not easy to make early withdrawals from one's 401k plan. The employer can put certain restrictions on them and even the government also makes it difficult for the employee to do so. However, under certain conditions, people can make penalty free early withdrawals too. These conditions are as follows-

* If a person retires or is fired from the job in or after the year he/she turns 55.

* In case of an individual's death.

* In case a person suffers from some permanent disability.

* In case the money is required to pay medical expenses of self, spouse or a dependent that exceed 7.5% of average gross income.

* If a court of law directs an individual to pay money to a divorced spouse.

Under certain other conditions, an individual can make early withdrawals but the penalty is levied in such situations-

* If the withdrawn amount is required to pay the medical bills and the employee is not covered under any insurance plan.

* If the withdrawn amount is required to pay debts to avoid eviction from one's primary residence.

* When the withdrawn amount is utilized to restructure or make some repairs in one's primary residence.

* In conditions when the amount is needed very urgently and all other loan options have already been exhausted.

* It can also be used to clear the funeral expenses incurred on spouse's or dependent's funeral.

Under certain other conditions an employee can use early withdrawals as loan. These loans however, again attract 10% penalty. The interest charged on the principle amount is 1-2% higher than the prime interest rates. The interest accrued is deposited back into one's own 401k plan only and it grows tax free. However, if an employee leaves the job or is terminated by the employer, then the loan amount has to be paid back with in a period of 60 days. Otherwise the employee might have to pay heavy penalties.