IRAs, or Individual Retirement Accounts, offer a similar list of hardship exceptions to the 10 percent penalty, but with two notable advantages: With IRAs, you can also make penalty free withdrawals to cover college expenses, and to purchase a home.
You may not feel like purchasing a home while you’re unemployed.
Remember, the maximum amount that may be distributed from the IRA on a penalty-free basis for the purpose of buying a first home is ,000. If you are under age 59½ when the distribution occurs, your IRA custodian may report the distribution as being eligible for an exception to the 10% penalty.
This is indicated with a code "2" in box 7 of Form 1099-R.
The IRS waives the penalty on early withdrawals from 401k plans if you execute a rollover to an IRA or other qualified retirement plan, or you are over age 55 and have left your employer.
For some public safety employees, that cutoff is age 50).
There is one significant trap that may affect the unemployed, however: Any withdrawals you take from a 401k plan could offset unemployment compensation.
Be sure to take a careful look at your state’s plan rules before you take anything out of a 401k, or you could render yourself ineligible for unemployment compensation altogether – just when you need it most.
This can provide a nice cash cushion, though you do lose a bit of tax-deferral benefit on any amounts you take as income.
Unless you are age 55 or older, you will also need to pay a 10 percent early distribution penalty.
Worse yet, this additional 10 percent is calculated based on the entire withdrawal – not just what you receive after taxes.
To take advantage of these provisions, though, you will have to execute a rollover to an IRA.
You cannot try it from your 401k, or you will run into the 20 percent withholding and 10 percent penalty issue.
You can have the 401k plan send you a check directly, but then the clock is ticking. If you screw up, you will pay taxes and penalties on the whole thing at once.