No individual likes to pay taxes. One of many ways to avoid it is to opt for the employer-sponsored retirement plan 401(k). By making contributions to this account, you can defer the payment of your tax. The fund has numerous advantages. You can assign a fixed percentage of your income into this fund while your employer matches it or contributes a certain percentage. Moreover, your contribution is not reported as income. Thus, it is neither taxed nor can be withheld by the employer. Another big advantage is that the gains that this fund procures because of investment also get exempted from tax.

Withdrawing from the 401(k) account

Judging by the advantages that the 401(K) account enjoys, it is not surprising to understand that the account grows into a sizeable amount in a short span of time. This makes you quite tempted to withdraw an amount from it in times of financial crisis like losing a job or when you are planning a big investment like purchasing a house, payment of college tuition fees. However, you should avoid giving in to the temptation as you might end up paying a higher tax.

The 10-percent tax penalty

The 401(k) fund works awesome until you decide to withdraw funds from it. The federal government gives you the tax deferral on it on the condition that you do not withdraw a single cent from it till you reach the retirement age of 59 ½ years. If you do withdraw before the magic age, you will need to pay an extra tax which will be equivalent to 10 percent of the amount that you have withdrawn from the 401(k) account which is also popularly known as the retirement account or IRA account. The idea behind this penalty by the government is to deter people from withdrawing the amount from this fund. Another big risk on withdrawing the fund from this account is that it can push your overall income in the higher tax bracket which will mean that you are paying a much higher tax than actually payable by you.

Ways to avoid the 10-percent tax penalty

The fact that you cannot withdraw a single penny from the account without attracting a 10 percent penalty might depress many. Fortunately, the U.S. tax code does cut some slack and make withdrawal easy for you in certain conditions. Let’s throw light on some of those exceptions to the rule.

  • Qualified medical expense

There can be a situation when you are faced with a massive medical bill. In this circumstance, you can actually withdraw money from your retirement fund without paying the additional tax. The stipulation for this withdrawal is that your unreimbursed medical expense has exceeded 7.5% of your adjusted gross income. You will need to pay the penalty if this condition is not met. In case you have collected unemployment cheque for twelve consecutive weeks and needed to pay for health insurance for your dependents and spouse, then you can withdraw as well without incurring any penalty.

  • Early retirement

If you are of 55 years of age or above, you can take distributions from your fund without any additional tax provided you are no longer getting into the job scene and have retired. However, this would become void if you rollover this plan to an IRA. Thus, you should be careful before taking up this leeway.

  • Disability

If due to any foreseen circumstances, a person has been certified as disabled by a state or a federal agency like Social Security Administration, then the penalty is waived off. The disability covers both physical and mental disability. It must be noted that this does not cover temporary illness which can be cured.

  • Miscellaneous

There are numerous other scenarios where you can withdraw money like:

  • Under qualified conditions, you can withdraw up to $10,000 per spouse without paying the early withdrawal penalty.
  • If you are making withdrawals at regular intervals as an annuity, you can avoid the penalty.
  • You are getting the fund amount as the nominee of the deceased account holder. Likewise, your beneficiary can get the fund without incurring any penalty.
  • For any qualified relations order issued by a court, you can withdraw without penalty. The classic case is divorce case where the fund needs to be distributed between two estranged spouses.  Finally, before you make a move on your IRA account, it is best that you consult our tax experts.