How One 401(k) Hardship Withdrawal Can Have Exponential Costs

10 Biggest Retirement Mistakes: #2. Taking A 401(k) Check

If you decide to transfer your 401(k) or other retirement assets to an IRA, make sure they go directly to the new custodian.

If your employer cuts you a check, the company will be required to withhold 20% for taxes and you will have to roll the entire amount — including the 20% you didn't receive — into an IRA within 60 days.

Any money not deposited into the IRA would be treated as a taxable distribution, subject to taxes and early-withdrawal penalties.

10 Biggest Retirement Mistakes: #6. Tapping Retirement Accounts Too Soon

If you tap your retirement funds before age 59 1/2, you'll owe 
a -10% early-withdrawal penalty on top of the federal and state income taxes you'll pay on each distribution.

But if you are at least 55 when you leave your job, you can take distributions from your 401(k) without paying a penalty (although you will still owe income taxes on your withdrawals).

If you transfer your funds to an IRA, you lose the “55-and-out” option.

10 Biggest Retirement Mistakes: #7. Interrupting Early IRA Payouts

A way exists to avoid early withdrawal penalties if you tap your IRA before you are 59 ½.

You must take “substantially equal periodic payments" from your IRA based on your life expectancy for at least five years or until you are 59 1/2, whichever is longer.

But if you deviate from the payout schedule, you'll owe a 10% penalty retroactive to your first withdrawal, plus interest.


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4 Ways to Avoid IRA Early Withdrawal Penalties

In a perfect world, pre-retirees would never have a need to dip into their IRA savings.

However, if special and unforeseen circumstances arise and one needs to dig into an IRA nest egg, U.S. News and World Report offers some ways to avoid the penalty for making an early withdrawal.

Medical Expenses. If you spend more than 7.5% of their income on unreimbursed medical expenses, you can use an IRA withdrawal to pay for health care above that amount.

Health Insurance. Workers who receive unemployment benefits for 12 consecutive weeks can use their IRA to pay for health insurance. Only distributions received during the year unemployment benefits were received or the year following are exempt from the penalty.

Annuity Payments. If early distributions are part of a series of payouts, and the distribution method is approved by the IRS, they can be taken without penalty. At least one withdrawal must be taken annually, and you must take distributions for five years or until you turn 59 ½. Payment amounts can be calculated based on a portion of the account balance, however.

Disability. If you become disabled before you turn 59 ½ and cannot work, you can take distributions without paying the penalty.