Q:

What is the 401K tax penalty for early cash-out?

A:

Quick Answer

The 401K tax penalty for early cash out is 10 percent of the amount of the distribution, which is in addition to the full amount of the regular income tax on the cash out. However, there are a number of exceptions that preclude the collection of the 10 percent penalty.

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Full Answer

A 401K retirement account holder under the age of 55 must pay the 10 percent penalty when cashing out the account. However, the penalty is waived if the account holder becomes completely disabled, dies, has a substantial medical expense, must use the money to pay alimony or child support, or has a levy on the 401K account from the IRS. Military reservists called to extended active duty can also cash out 401K accounts without penalty. Another tax drawback of cashing out a 401K account early is that the extra income may put account holders into a higher tax bracket, making them subject to a higher income tax payment.

Instead of cashing out the account, 401K account holders can borrow up to $50,000 or half of the account's balance and pay it back with interest over five years without incurring the 10 percent penalty. Account holders can also opt for a series of substantially equal periodic payments over their expected lifetimes as long as they are no longer working for the employers maintaining the plans before payments begin.

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