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How are 401k withdrawals penalized?

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Quick Answer

Most 401(k) withdrawals incur a 10 percent penalty if the individual is under age 59 1/2. The taxpayer is also required to pay taxes according to his income level for the year, including the money he withdraws. There are some ways to escape the penalties.

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Full Answer

The law provides a tax deferment for taxpayers who place money aside for retirement in a 401(k) account. However, the government expects the money to remain there until he reaches retirement age. To discourage early withdrawal, these accounts include a penalty. Employers are not required to allow hardship withdrawals from the account, but if the plan allows for such withdrawals, the employer must apply the rules equally to all employees. Examples of hardships include medical or funeral expenses. Some plans allow withdrawals for a first-time homebuyer or a child's college tuition. The IRS does not allow for emergency withdrawals for buying a new television or boat.

Borrowing against a 401(k) plan offers a tax-free way of withdrawing money without paying tax on it. It is the method preferred by financial experts, according to SFGate. The plan holder is able to borrow up to 50 percent of the funds in the 401(k) account or $50,000, whichever is less, but must repay the money, with interest, within 5 years. The advantage of this type of loan is that the taxpayer is paying himself the interest.

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