An employer-sponsored 401k provides you with a convenient way to save money for your retirement years. Rules exist that limit access to 401k funds before retirement age, but if you become disabled, you can access the money sooner than that.
Both you and your employer can contribute money to your 401k account. You deposit this money on a pre-tax basis, and the account grows tax-deferred. This means you only have to pay tax when you make withdrawals. The Internal Revenue Service regards age 59 1/2 as the official retirement age. You normally have to pay a 10 percent tax penalty on 401k withdrawals made prior to this age. You pay this in addition to federal and state income tax.
You don't have to pay the 10 percent premature-withdrawal penalty if you withdraw 401k funds as the result of a long-term disability. However, you can't avoid paying regular state and federal income tax. Most 401k plans contain a mixture of stocks, bonds and mutual funds. You can instruct the plan custodian to liquidate these assets and mail you a check with the sale proceeds. This process normally takes about a week, and the custodian normally withholds 20 percent of your cash to cover income tax. You may get some of this money back at the end of the tax year if you fall into a lower tax bracket.
To make a penalty-free 401k withdrawal, you must have a mental or physical condition that prevents you from engaging in gainful activities or work. The condition must be expected to last for at least 12 months. Your condition must be diagnosed by a physician, and you may have to turn in a physician's letter to the IRS. This not only enables you to gain access your 401k funds without penalty, but it also means you're potentially able to claim a disability federal tax credit.
The money that you deposit in your 401k account belongs to you, but the money that your employer contributes still belongs to your employer for a period of time. Employer contributions gradually become yours through a process known as vesting. Under federal laws, a 401k plan may have a five-year vesting schedule, which means your employer's contributions become yours at a rate of 20 percent per year. Disability or not, you lose nonvested funds when you cash in your 401k.
- Jupiterimages/Photos.com/Getty Images