Allowable 401k Distributions

• There are only a few circumstances in which you can take a distribution from your 401k plan. The primary options are if you become disabled, if you turn age 59 1/2, if you have a financial hardship or if you separate from service with your employer. If you die, your beneficiaries can also distribute the proceeds of your account. The final option is if the plan terminates and your employer offers no defined contribution plan in its place.
  
  

Early Distribution Penalty

• The early distribution penalty for 401k withdrawals is 10 percent, the same as with other types of retirement plans, such as IRAs. The IRS assesses this penalty if you withdraw from your 401k before you reach age 59 1/2. Certain circumstances may exclude you from the 10 percent penalty. Examples include distributions due to disability or death, as part of a series of substantially equal payments for life and for separation from service after age 55. Other less common exceptions are also available.
  
  

Taxation

• If you take a distribution from your 401k plan, regardless of your reason, you must pay tax on it. You have never paid tax on either the contributions or the earnings in your 401k, so when the money comes out, you must pay the tax then. This rule applies even for hardship distributions, and is in addition to the early withdrawal penalty, if applicable.
  
  

401k Loans

• While the IRS does not require employers to offer a 401k loan option, many employers do. If you take a loan from your 401k, it is not a distribution and is therefore not subject to either the early distribution penalties or the taxation of bona fide distributions. However, if you leave your employer for any reason, then you must repay the loan in full immediately or the IRS will consider it a distribution. You will have to pay tax on the balance of your loan, and you will face the 10 percent early withdrawal penalty if you are under 59 1/2.