A 401(k) is an employer-sponsored retirement plan allowing workers to put money aside for retirement. Plans vary with employers on such issues as vesting options or length of time required before an employee can take out employer contributions as well as required withdrawals other than those mandated by the Internal Revenue Service. In general, the earliest 401(k) money can be withdrawn is age 55.
Withdrawals from a 401(k) before age 59 1/2 are subject to a 10 percent penalty unless they qualify as a hardship, both under rules of the plan and IRS regulations. An exception occurs when an employee leaves the service of the 401(k) sponsor after age 55 -- or age 50 for public safety workers. You can't take another job, however. Withdrawals due to excess contributions, a divorce order or an IRS tax levy also are exempt.
Withdrawing 401(k) plans before an employee is fully vested in the plan can cost access to the employer's contributions. An employee can always withdraw his contributions, but each plan has rules on how long an account must be held before the employee is entitled to the full benefits. Any withdrawal from a traditional 401(k) will be taxed as ordinary income.
Taking 401(k) money as "substantially equal periodic payments" after leaving the employer will avoid the 10 percent penalty, but not regular income taxes. Payments must be calculated based on IRS tables on the life expectancy of the account holder and any beneficiary. They must continue for at least five years or until age 59 1/2, whichever is longer.
Each plan can define hardship exceptions and none are required to offer this option, but the IRS defines hardship as a significant financial need that cannot be met by any other resources. These include disability, medical expenses above 7.5 percent of income, higher education expenses and up to $10,000 for a first-time home purchase. The home purchase option, however, is allowed only if an account owner has first tried to take a loan from the 401(k).
Loans are an easy way to withdraw money temporarily from a 401(k). An account owner can borrow up to 50 percent of the balance, up to $50,000, whichever is less. Loans must be repaid within five years, but interest on the loan goes into the 401(k) balance. This reduces the amount earning interest and repayments must be made with after-tax money. If the money isn't repaid within the time limit, the loan will be considered a distribution subject to taxes and penalties.
Withdrawals from 401(k) plans have to start at age 70 1/2, with a required minimum amount based on funds in the account and IRS tables for life expectancy. The first withdrawal can be delayed until April 1 of the year after reaching 70 1/2, but a second distribution must be taken before Dec. 31 of that year. Withdrawals have to be made annually before Dec. 31. All distributions from a traditional 401(k) are taxed as ordinary income.