Q. I recently lost my job and rolled my 401(k) plan into a traditional IRA. But I’m still unemployed and need to withdraw some of that money to pay my rent and utility bills. Would this qualify for some sort of hardship withdrawal, and can I avoid paying a penalty or taxes on this money?
A. Probably not.
When is the Penalty Waived for Making an Early 401k Withdrawal?
The IRS takes a fairly unforgiving stance on withdrawals from a traditional IRA for people under age 59 1/2.
They are almost always subject to a 10% penalty, plus regular income tax on the portion that reflects the return of tax-deductible contributions and investment earnings. In the case of your 401(k) rollover, that means taxes would probably apply to the entire amount of the withdrawal.
The penalty is only waived if:
- You are totally disabled.
- You pay deductible medical expenses that exceed 7.5% of your adjusted gross income. In this case, you only pay a penalty on distributions below the 7.5% threshold.
- You pay for medical insurance, have lost a job and have received unemployment compensation for at least 12 weeks. In this case, no penalty is applied to the withdrawal up to the amount of the insurance.
- You are a first-time home buyer and take out no more than $10,000 to cover qualifying home buying expenses.
- You use the money to pay for qualifying higher education expenses.
- You die before age 59 ½. (In this case your beneficiaries avoid the penalty.)
- You are a member of a military reserve and are eligible for qualified reservist distributions.
- The distribution is part of a series of roughly equal payments received at least annually over your life expectancy (or the joint life expectancy of you and a beneficiary).
IRS Publication 590 has more information on these exceptions to the 10% penalty. To report penalty-free withdrawals, you need to file IRS Form 5329.
But based on what you’ve told us, it doesn’t appear that any of these exceptions apply to your situation.
Early withdrawals must always be reported as income on your federal taxes. There is no list of exceptions for that rule.
The Bottom Line
It looks like you’ll have to pay both the penalty and income taxes on any money you withdraw.
But before you do that, ask a CPA or tax attorney to review your financial records and offer a professional opinion on how much you must pay and what you might be able to do to reduce your overall tax liability.