Congress created the 401(k) in 1978, and companies started widely adopting the plans in the 1980s. A 401(k) plan allows both you and your employer to contribute pre-tax money toward your retirement. Because of the tax advantages you gain, the government requires you to wait until you are 59 1/2 to take money out of the account and charges you a 10 percent penalty if you take money out before that. However, there are ways to waive the early withdrawal penalty.
There are several medically related reasons for which you can tap the money in your 401(k) plan early and not have to pay the 10 percent penalty. For example, if you incur unreimbursed medical expenses that total more than 7.5 percent of your adjusted gross income, you can take money from your 401(k) penalty-free to pay for them. You can also take money early from your 401(k) to pay health insurance premiums if you are unemployed for more than 12 weeks out of the year. You also can gain a medical exemption to the early withdrawal penalty if you become fully and permanently disabled.
You can tap your 401(k) early without penalty if you are facing specific financial issues. If you owe the Internal Revenue Service for back taxes, you can take 401(k) money penalty-free to pay the bill. You can also tap your 401(k) without penalty to pay court-ordered child or spousal support. If you are laid off from your job at age 55 or later, you can take money out of your 401(k) without penalty.
There are a couple of other situations that allow for early 401(k) withdrawals without penalty. If you die, your beneficiaries can take money out of your 401(k) without penalty. However, if your spouse inherits the account and wants to treat it as her own, she must follow the same rules and cannot take money out until she turns 59 1/2. Another instance in which you can tap your 401(k) penalty-free is if you retire early and take equal payments from it for at least five years.
Some hardship withdrawals don't qualify to have the the 10 percent penalty waived, including taking out money for a down payment on a first home and using money for education expenses. Evenn if your early withdrawal qualifies for an exemption from the 10 percent penalty, you will still have to pay income tax on the amount of your withdrawal at whatever your current income tax rate is. An alternative, if your company offers it, is a 401(k) loan. With a loan, you can borrow up to half your 401(k) balance, and then you have up to five years to pay the money back, with interest.