401k Early Retirement? Any Penalties?

The 401k early retirement rules are no different from any other retirement provision plan's early retirement rules.

Retirement provision plans were designed to discourage you from withdrawing from the plan before you are within six months of your sixtieth birthday. There are thus penalties – in the form of an additional tax – over and above the normal income tax you would be liable for on the income received from the plan.

However, the good news is that there are ways whereby you could avoid this penalty. Under normal circumstances there would be a 10% additional tax if you want to withdraw funds from your 401k plan before you are within six months of your sixtieth birthday.

A word of caution here. Any plan, also the 401k plan, grow exponentially the longer you contribute to it and/or the longer you refrain from withdrawing from it. We are discussing early retirement here, not a loan nor becoming disabled.

Every withdrawal from your 401k plan means sacrificing important benefits of a previous 401k plan contribution. Each contribution to your 401k plan is rewarded with tax benefits. Not only is your contribution tax deductible, but also the investment growth of your account is tax-deferred.

There are two ways in which you can avoid penalties on your early retirement withdrawals:

Substantially Equal Payments

This option is available for 401k retirement at any pre-retirement age. However, the withdrawals from your plan must be "substantially equal" and be based upon the your life expectancy. Once the withdrawals started, the "substantially equal payments" must run for at least five years, or until you are within six months of your sixtieth birthday.

Beware! This option will often give you the poorest retirement payout of all the options available.

Retire, or leaving your job, on or after your 55th birthday

Needless to say, if you retire or resign from your job at this age you'll need your employer's consent to start withdrawing from your 401k plan. This applies also if you were retrenched or fired from your job on or after your 55th birthday. But you will avoid the penalty.

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