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How to Withdraw Money from Your Company Retirement Plan Without Paying the 10% Penalty

From Inside Personal Finance

You have an IRA. You have company retirement accounts. You have an annuity. These accounts enable you to defer paying annual income taxes on the profits, but there’s a catch: Any withdrawals prior to age 59½ are subject to taxes plus a 10% penalty.

What many people do not realize is that the penalty can be avoided. This article shows you how -- but before you attempt any of the following, talk with your financial and/or tax advisor and review the strategy you are about to execute. Fail to implement the strategy properly, and you are likely to be assessed not just the 10% early withdrawal penalty but additional interest charges as well. And keep in mind that even though the following enables you to avoid the 10% penalty, ordinary income taxes are still owed, along with whatever surrender charges might be applicable from the IRA account itself.

Having said that, you can receive money from your tax-deferred account and avoid the 10% IRS penalty if you withdraw the funds using one of the following exceptions:

1. You establish a series of substantially equal periodic payments (based on Section 72(t) of the Internal Revenue Code) that are made at least annually and continue for the course of your life expectancy (or the joint life expectancies of you and your designated beneficiary). If taking money from a company plan, payments cannot begin until you leave the employer. Once you begin this process, you cannot make any changes until you reach age 59½, or until five years has passed, whichever is longer.
2. You become disabled prior to 59½.
3. You separate from service after age 55, meaning you quit, retire or are discharged from your employer. 
4. You get divorced, and the money is distributed to you in accordance with a Qualified Domestic Relations Order, issued by the judge.
5. You use the money to pay for qualified medical expenses. Among other requirements, such expenses must exceed 7½% of your Adjusted Gross Income.
6. You contributed too much money to your IRA or retirement plan, and you remove the excess from your IRA (or your employer returns the excess plan contribution to you). The return of excess contributions is not subject to the 10% early withdrawal penalty. However, if the excess contributions are not removed in a timely manner, additional penalties and interest could apply, dwarfing the 10% penalty.
7. An employer’s matching contribution to your 401(k) was excessive; amounts returned to you are not subject to the penalty.
8. You made voluntary deferrals to your 401(k) plan in excess of IRS limits. These refunds are not subject to the penalty.
9. You receive dividends from stock that is part of an Employee Stock Option Plan; such dividends can be received without penalty.
10. You die. (Aren’t the tax rule writers nice?) 
    

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