- To take money out of a 401k as a so-called qualified withdrawal, the account holder must be 59 and half years or older as prescribed in the 401k rules. There is a 10 percent excess tax penalty for any unqualified early withdrawals, generally known as hardship withdrawals. Qualified, penalty-free early withdrawals are very rare and only the few exceptions made available under special circumstances such as covering certain medical expenses, becoming permanently disabled or following a domestic court order. No other early withdrawals may be requested, and certainly won't be approved, under the 401k rules.
- Special withdrawals are the early withdrawals permitted under 401k rules and without incurring the 10 percent penalty. Special early withdrawals are intended for covering tax-deductible medical expenses (the amount of medical expenses in excess of 7.5 percent of the account holder's adjusted gross income under federal tax rules), using as a source of income for permanently disabled persons, satisfying any domestic relations court order that directs 401k withdrawals for dependent support, or providing income for persons of 55 or older without a job.
- Hardship withdrawals are permitted unqualified early withdrawals that if approved will incur a 10 percent penalty on the amount withdrawn. To apply for a hardship withdrawal, four conditions must be met: the financial need is immediate and severe, no other funds are available to meet the need, other 401k withdrawals or loans have been first obtained, and the amount withdrawn doesn't exceed the amount needed. To gain approval of a hardship withdrawal, funds withdrawn must be used for one of the following purposes: medical expenses not reimbursed and non-tax deductible, payments to buy principal residence, funds needed to prevent eviction or foreclosure, higher-education costs due in the next 12 months, expenses for repairing damage to principal home, and funeral spending for a family member.
- 401k loans are also penalty-free withdrawals. Unlike other withdrawals in which the account holder pays back the withheld income tax at the time of the withdrawal, 401k loans are not subject to income tax unless a loan is in default. The benefit of taking money out for temporary use in the form of a 401k loan is that the amount of money taken out, plus interest, can be later paid back to the account for the same tax-deferred status, whereas any other withdrawals can not be replaced and are lost forever from the 401k account. However, the account holder must use after-tax income to make any loan payments.
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