401k's were designed to help us put away money for retirement and not make a withdrawal on it until then. If you want to make a 401k withdrawal before retirement then you will most likely be penalized for it. You can make withdrawals without penalties beginning at age 59 1/2 and must make withdrawals before reaching age 70 1/2.
There are two different types of withdrawals: financial hardship withdrawal and no-penalty withdrawal.
Financial hardship withdrawals must meet some criteria. First of all the withdrawal must be necessary due to an urgent and significant financial need (a new car is not included!). Second, you can't get the money from anywhere else and the money must be for the amount you need (not for more). Finally, you must have already taken out all loans available to you through your 401k plan. If these criteria are met, then there are a few circumstances for which you can make a financial hardship 401k withdrawal:
- To purchase a primary residence
- To prevent foreclosure on your primary residence or eviction from your home
- To pay tuition for yourself, your spouse, or a dependent
- To pay medical expenses that cannot be reimbursed for you
The downside to financial hardship 401k withdrawals is that you must pay taxes on the money you withdraw and it is subject to a 10% penalty. If you take out $20,000, for example, you will be penalized $2000 and you'll have to pay taxes around $5000 (depending on your tax bracket). This would only leave you with around $13,000. That stinks.
No penalty 401k withdrawals are still taxable but don't have the 10% penalty attached. These can include:
- Pemanent disability
- Medical debts that exceed 7.5% of your adjusted gross income
- A court orders you to give the money to a divorced spouse or a dependent
- You stop working (layed off, quit, early retirement) the year you turn 55 or later
- You stop working and begin taking out regular payments based on a schedule that will make equal payments for the rest of your expected life; these must last for 5 years or until you turn 59 1/2, whichever is longer
The above summarizes the federal 401k withdrawal rules, but you are also subject to your employer's withdrawal rules. Your employer does not have to allow you any financial hardship withdrawals, although many do.