In this tough economy, you may be tempted to take an early withdrawal -- before age 59½ -- from your employer's qualified retirement plan. But don't do so without considering the tax implications, including the possibility of getting socked with a 10% premature withdrawal penalty.
Surprisingly enough, there is no penalty exception specifically for retirement plan hardship withdrawals (often the only way to get money out of a plan without leaving your job). However, you may be able to avoid the penalty if you qualify for one of the exceptions explained below. (How much will you 401k provide? Find out with MSN Money's calculator.)
Early withdrawal basics
In most cases, all or part of any withdrawal from a qualified retirement plan, such as a 401k plan or IRA, will be hit with income tax. The taxable portion depends on whether you have made any nondeductible contributions. The terms of the plan may allow you to take an early withdrawal (before age 59½ ) in limited circumstances such as financial hardship. If so, the taxable portion of the early withdrawal will be socked with the 10% premature withdrawal penalty, on top of the income tax hit, unless one of the penalty exceptions applies.
Note: Congress did not have enough sense to make the exceptions for early retirement plan withdrawals exactly the same as the exceptions for early IRA withdrawals. You can find the IRA exceptions here. (Should you convert to a Roth IRA? Find out with MSN Money's calculator.)
Exception for withdrawals after separating from service
Perhaps the most common penalty exception for early withdrawals is when you "separate from service" at age 55 or older for any reason (quitting, retiring or getting laid off). In this case, you are exempt from the 10% penalty. If you are a qualified public safety employee (such as a police officer or firefighter) who separates from service at age 50 or older, you can receive penalty-free payments from a governmental defined benefit plan.
Important point: If you qualify for the separation-from-service exception, you should not roll over retirement plan money that you expect to need in the relatively near future into a traditional IRA. Why? Because early IRA withdrawals (before age 59½) will be hit by the 10% penalty unless one of the IRA exceptions is available.
Exception for substantially equal periodic payments
Another penalty exception is for what the IRS calls substantially equal periodic payments. SEPPs are annuity-like withdrawals that you must take at least annually. There are three methods for calculating them. One is relatively simple; the others are complicated. The amount of the penalty-free SEPP that you can take each year can vary by thousands of dollars, depending on which method you choose. You must continue taking SEPPs from the annuitized account for at least five years or until age 59½, whichever comes later. If you don't stick with the program, the taxable portion of all withdrawals taken before age 59½ from the annuitized account can be hit with the 10% penalty tax.
These aren't the "Good Old Days" anymore!!
