There are two major 401(k) penalties that you should attempt to avoid as an investor. Both 401(k) penalties will cut into your retirement nest egg substantially and cost you a significant amount of money.
#1 401(k) Penalty - The 10% Early Withdrawal Penalty Tax
When you take money out of your 401(k) account, you have to pay ordinary income taxes on the withdrawal. There is a catch, though. The most commonly known 401(k) penalty is the special, additional 10% penalty tax on 401(k) withdrawals made before you are 59.5 years old. This is a punishment designed by the government to force you to keep your money invested for retirement in hopes of lessening the reliance upon social welfare programs.
#2 401(k) Penalty - Surtaxes on Excess 401(k) Contributions
Congress is very specific when setting the 401(k) contribution limits that determine the maximum amount of money you can put into your account each year. If you exceed these rigid 401(k) contribution limits, you are guilty of making what is known as an excess contribution. This subjects you to an additional penalty excise tax. Specifically, according to Fidelity, one of the largest 401(k) plan administrators in the world, "The penalty for excess contributions is 6 percent. The 6 percent is assessed on the amount of the overage. This penalty is an excise tax. If you remove the excess amount prior to the end of the tax year, you will not be assessed a penalty on the excess contribution amount."
The good news is you might have a chance at avoiding this 401(k) penalty if you get the excess contribution out of your account before the tax deadline for the year it was contributed. For more information, contact your tax accountant.
