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Retirement savings compete with day-to-day expenses for your hard-earned money, so it’s a great accomplishment to put anything away in your 401(k) or IRA. Once you have done so, you may be on the way to a healthy and stress-free retirement. Unfortunately, it only takes a few actions to undo your positive contributions and jeopardize your financial security.
Withdrawing your money too soon is one such mistake. If you withdraw money from your 401(k) before age 59 1/2, not only will you have to pay any taxes owed on your pre-tax contributions, but you will owe a 10% penalty. That’s very steep and it will quickly make your gains disappear.
There are some ways to withdraw the money early without paying this penalty, but the rules are tight and your company may not even allow it. This article from Kiplinger’s Personal Finance describes one such exception:
… [I]f you are at least 55 in the year you leave your job, you may be able to start taking distributions from your 401(k) without paying a penalty, withdrawing as much as you like (but you will still owe income taxes on your withdrawals). The key is to keep your money in your employer’s plan when you retire. If you transfer it to an IRA, you’ll lose the “55-and-out” option.
Fidelity also provides details about 401(k) withdrawals, explaining some of the cases in which you may withdraw funds free of penalty, including annual withdrawals throughout your life expectancy, disability, an a few others.
In general, these withdrawals should be a last resort. Even taking a loan from your 401(k) would be a better idea if the need for the money in the account is strong. That’s still not a path I’d like to take for myself.
Updated September 17, 2011 and originally published June 11, 2007.