A 401k is a tax-deferred type of retirement plan in the US. The retirement savings account is tax-deferred because employees of a company can make pre-tax contributions to the account. In addition, the money contributed to a 401k account is also not included as taxable income on the personal tax returns of the employee. Potential 401k tax penalties, however, do arise if employees do not follow rollover rules when leaving a company, make early withdrawals from the account or take a loan from the 401k account before they reach retirement age.
When an employee has a 401k plan with an employer, but leaves the company or is fired, the employee has a set period of time in which to roll the money and investments in the 401k plan over into an individual retirement account (IRA). If the employee does not roll over the money from the 401k into the IRA during the timeframe, then 401k tax penalties may occur. In essence, this is considered to be an early withdrawal because the money is taken out of the 401k without being deposited into another type of retirement account.
When a 401k account holder makes early withdrawals from the account, the amount of the withdrawal incurs 401k tax penalties. According to the Internal Revenue Service (IRS), early withdrawals are any withdrawals made before the account holder reaches the age of 59 ½. The 401k tax penalties are 10% of the amount of the withdrawal. Early withdrawals constitute withdrawing a portion of the money in the 401k plan. 401 tax penalties for early withdraws also occur when an employee withdraws all of the money out of the retirement savings account.
Some 401k accounts allow employees to take loans from their 401k account. Whether or not this is allowed depends on the type of 401k the employer establishes for the employees. Loans from a 401k are typically for financial hardship reasons, such as a major illness. When employee takes loans from this type of retirement account, then 401k tax penalties typically apply to the amount the employee withdraws from the account.
In the situation of a loan from a 401k, employees must typically repay the loan amount. The money that is placed back into the account, however, is after-tax money. While this is not a direct penalty, it means that taxes have already been deducted from the income of the employee prior to repaying the loan.