Tax Tip from the week of November 3, 2008

Know the tax rules for retirement plan withdrawals

You already know the many sound financial reasons for not taking money out of retirement accounts early. Unfortunately, emergencies happen — so you may also want to know the tax consequences if you're forced to consider a withdrawal from your 401(k) account before age 59½.

Here's an overview of the rules for two types of distributions.

• Hardship withdrawals. When you need funds to pay an immediate and heavy financial burden such as certain medical or tuition expenses, you might be able to withdraw the value of your pretax contributions from your 401(k).
  
  Under current law, "hardship" distributions are generally taxable to you as ordinary income. In addition, a 10% early withdrawal penalty typically applies.

• Loans. Depending on plan provisions, you may be able to borrow part of your vested balance from your 401(k). Like loans obtained from other lenders, the proceeds are tax and penalty free — as long as you repay the money received according to the terms of your plan. Interest you pay on the loan is not tax deductible.
  
  If you default — for example, by leaving your employer without repaying the loan balance — the withdrawal is considered a taxable distribution. You may also owe the 10% early withdrawal penalty.

Please contact us if you're thinking of taking early withdrawals from your 401(k). We can help you assess the tax impact and explore other options.