Withdrawing Money from 401K for Living Expense or Debt Repayment is Costly

As the economy weakens and prices soar, it is tempting to raid your 401K account to get some money to pay for living expenses or repayments of debts.

While that sounds like a quick fix to your money problems and a chance to get your head above water financially, you may not realize how costly the tax consequences and penalties are for early withdrawal from your 401K account.

For people in the middle to upper income level who take money from their 401K accounts, the cost can easily be up to half of the withdrawal in federal and state taxes and the 10 percent penalty for early withdrawal.

Many people who make early withdrawals from their 401K accounts underestimate how much it will cost, then don't have the money to pay the taxes on the 401K withdrawal when it comes due.

The number of people withdrawing money early from their 401K accounts is on the rise,, due to the slow economy. It is usually a bad idea to make a withdrawal from your 401K for anything other than your retirement, but if you must take money from your 401K, there are certain circumstances under which the 10 percent penalty will be waived for early withdrawal.

If the distribution of 401K money was made to your beneficiary or your estate after your death.

If you withdraw money from your 401K because you became totally and permanently disabled.

If the money you withdraw from your 401K goes to pay certain non-reimbursed medical expenses.

If the money goes to pay an IRS levy.

If you are a Reservist called into active duty during a certain time period.

If your 401K withdrawal is part of a series of equal periodic payments made to you over your life expectancy.

You will avoid having to pay the 10% penalty for early 401K withdrawal for the six reasons mentioned above, or if you leave your employer after you reach age 55.

The IRS does allow for certain hardship withdrawals, however, employees must prove they have a heavy and immediate financial need before they can make a hardship withdrawal from their 401K accounts, and the 10 percent penalty will still be owed for hardship withdrawals.