How Early Withdrawals Can Tax Your Retirement Savings

Cathy Yeulet/Getty Images Taking money out of your 401(k) before age 59½ typically results in taxes and penalties on the amount withdrawn. Investors who take early withdrawals also miss out on the tax-deferred growth their savings would have accumulated if they had left the money in the 401(k) plan or rolled it over to an individual retirement account. Here's what happens when you take an early 401(k) withdrawal and how to limit the fallout. Income tax. Regular income tax is due on each withdrawal from your traditional 401(k) plan. A worker in the 25 percent tax bracket who withdraws $10,000 from a 401(k) plan will owe $2,500 in federal income taxes on it, and perhaps more in state income taxes. When you receive a 401(k) distribution, 20 percent will typically be withheld for income tax purposes. So, when you withdraw $10,000 from a 401(k) account, you will actually only receive $8,000. You will need to come up with any additional tax you owe from the distribution itself or another source. "Many people who have cash-outs when they leave a job often are not leaving their job voluntarily, and some of this is being used as a temporary stopgap measure," says Jack VanDerhei, research director of the Employee Benefit Research Institute. "If you have a situation where you don't absolutely have to have the money, you should keep as much in the tax-advantaged accounts as possible."