401k Retirement Plan Withdrawal Rules

The goal of contributing towards a 401k retirement plan is for you to be able to retire with a good solid income. This is proven by the fact that 401k plans allow you to take out a certain amount (maximum limit of $15000 in 2006) from your Gross Income and contribute it towards the 401k retirement account, allowing it to grow tax-deferred.

However, do you have the option of withdrawing this money before your retirement? What if you need cash for an emergency such as death of spouse, large medical bill or a home refinance mortgage? We suggest that you make withdrawing money from a 401k as your last possible option.

Rules Governing 401k Withdrawals

- Most 401k retirement plans do not allow you to withdraw money unless you are facing some kind of a financial hardship. This is why some 401k withdrawals are also known as "401k hardship withdrawals." The above mentioned reasons such as death of a spouse (which is beyond human control) or a large medical bill are valid financial hardships.

- Most employers set 401k withdrawal rules with guidelines set up by Internal Revenue Service. Therefore, if you have an immediate need for cash (supported by an important reason), then you are eligible to make 401k withdrawals. Here are some of the reasons that allow you to make 401k hardship withdrawals:

1) Large medical bills for you, your spouse or family
2) Buying a house (your primary residence) - this excludes the mortgage payments
3) Paying university and post-secondary school fees for your children, dependents, spouse, etc
4) To prevent foreclosure of your home
Note: If you take a 401k hardship withdrawal for any of these reasons, you will not be allowed to make any annual 401k contributions for atleast 6 months. You are therefore suspended from making 401k retirement contributions for 6 months.

Economic Growth and Tax Relief Reconciliation Act of 2001 and 401k Hardship Withdrawals

Thanks to the reforms brought about by the Economic Growth and Tax Relief Reconciliation Act of 2001, 401k hardships are:

- NOT eligible for rollovers (into an IRA, etc)
- NOT subject to federal income taxes (however under certain circumstances, if you withdraw money before the age of 59.5, you will be subject to 10% penalty fee as well as local federal and state taxes).