Sep Ira

How To Avoid The 401K Tax Penalty

Along with the benefits of a 401k plan, there are restrictions and responsibilities. Many people have questions about the 401k tax penalty.

If you plan carefully, you may never have to worry about a 401k tax penalty. If you abide by the investment guidelines, and meet your minimum required distribution at the right time, you won't be penalized.

Taking the money out before retirement is usually only allowed if you are having a qualifying financial hardship, such eviction, foreclosure, medical bills and post secondary education expenses. It is possible that you will be suspended from contributing to the account for six months or more if you claim hardship. You will also be subject to heavy taxation, so it is greatly to your benefit to wait until you retire to distribute any funds.

The year that you reach 70 ½ years old, you will have a Minimum Required Distribution (MRD), unless you have not retired by this time. If you retire after this age, your MRD will take effect April 1st the year following your retirement. There is a 401k tax penalty of 50%, in addition to your other taxes, if you do not withdraw at least the MRD by the set time. The amount of your MRD is typically calculated by dividing the adjusted value of your account by a certain amount, depending on your age, using the Uniform Lifetime Table. For example, if your account is worth $50,000, and you are 73, your MRD would be 50,000/24.7 which equals $2,024.29.

As you can see, the 401k tax penalty is related to distribution. There is a fixed time where the money should not be removed, and there is a fixed time where some of the money should be removed. Before opening a 401k account, you should consider these restrictions. Of course, hardships are often unpredictable, but careful planning can help you to avoid such penalties. If you feel that you will be able to part with a small fraction of your income for several years without problems, this type of account may be right for you.

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