Tax Implications of Early 401(k)

Early 401(k) plan distributions must be reported on your tax return.
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It's harder than you might expect to get out the money in your 401(k) plan: You can only take an early distribution in the case of certain types of financial hardship or when you leave your job. In addition, the Internal Revenue Service imposes extra tax penalties on early withdrawals unless an exception applies.

Early 401(k) Distributions Defined

The criteria for an early withdrawal from a 401(k) plan depend on whether you're taking the money out of a traditional 401(k) or a Roth 401(k). For traditional 401(k)s, any distribution before you turn 59 1/2 is considered an early withdrawal. For Roth 401(k)s, if you don't meet both of two conditions for a qualified withdrawal, you'll have an early withdrawal. Besides the 59 1/2 years old requirement, Roth 401(k)s also require that you have opened the Roth 401(k) at least five years prior to the distribution.

Taxable Portion

With a traditional 401(k) plan, the distributions are fully taxable unless you've made non-deductible contributions. If so, the taxable portion is figured the same way as Roth 401(k) early distributions: You prorate the amount of the early distribution based on the composition of your plan. For example, say you have $24,000 of after-tax contributions in your Roth 401(k) plan and the total value is $30,000. When you take an early withdrawal, only 20 percent of the withdrawal counts as taxable income.

Early Withdrawal Penalty

To discourage early withdrawals, the IRS tacks on an extra 10 percent tax, usually referred to as a penalty, on the taxable portion of your distribution. If your entire distribution is taxable, you'll pay the extra 10 percent penalty on your entire distribution. If all of your distribution is tax-free, you don't have to worry about the penalty. However, if an exception applies, you get out of paying the extra tax. (ref 1)


The IRS does recognize a few exceptions that allow you to get out of the early withdrawal penalty. For example, if you're permanently disabled or you're at least 55 years old when you leave your job, regardless of whether you're retiring or get fired, you can take as much out as you want without paying the extra penalty. Other exceptions include distributions to pay a qualified domestic relations order or to cover medical expenses that exceed 7.5 percent of your adjusted gross income.

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