401(k)s for Dummies

What is the best known 401k salary limit?

"Federal dollar limit for pre-tax salary deferrals"

What is "vest" and how does it relate to a 401k plan?

"vest" means "to belong to you". You may have to stay with your company for a minimum length of time before the employer contributions vest, or belong to you.

If your plan requires you to work for one year before becoming eligible for the 401k plan, different definitions of "year" are possible. What are the two definition of years?

- 12 months of employment - At least 1,000 hours of work during the course of 12 months of employment

What is the annual fee for an index fund usually?

.20 - .40%

What is the annual fee for an actively managed stock fund usually?

1 -1.5% Known as the fund's "expense ratio".

What's the maximum length of time an employer can make you wait before you're allowed to participate in a company's 401k plan?

1 year.

What are "in-service withdrawals"?

1. Withdrawing money when you hit 59 and 1/2 years of age. 2. Hardship withdrawals. It is called in-service withdrawals because you make them while you're "in the service of" your employer.

In most cases, 401k fees are deducted from where?

401k fees are deducted from your investment return (the money being earned by your investments)

Companies aren't required to offer ...

401k plans. They're also not required to let all employees join the 401k plan immediately.

Even if your 401k plan allows you to withdraw money while you're still working, if you're under ...

59 1/2 years old, withdrawals can be difficult and costly.

What is an "actively managed fund"?

Actively managed funds have fund managers who constantly buy and sell stocks to try to improve the fund's return. These will generally have a higher investment fee than an index fund that doesn't involve a manager who picks the investments.

What is an "entry date" for a 401k?

An entry date is the first date you can actually contribute to the plan after satisfying the eligibility requirements.

How can your employer resolve failing the nondiscrimination test?

By giving an extra contribution to some or all of the lower-paid employees to make up for the discrepancy. This contribution is called a QMAC (Qualified Matching Contribution) or QNEC (Qualified Nonelective Contribution). This option is less popular among employers, because it costs them extra and it's complicated.

A small number of 401k plans use what's called "automatic enrollment". What is automatic enrollment?

Eligible employees are automatically signed up for the plan unless they refuse in writing. A percentage of salary is deferred into the plan for automatically enrolled employees, and often is deposited in the most conservative investment option.

Why are nonresident aliens excluded from 401ks?

Employers are allowed to exclude employees who live outside the US and ARE NOT US Citizens from participating in the plan. However, employees who are residents of the US but are not US citizens can't be excluded simply because they're not US citizens.

Employers aren't required to offer what?

Employers are not required to offer a retirement plan, nor are they required to contribute to a 401k plan.

A 401k plan provides a service to you so it is not ...

FREE. A 401k plan is not free. You're charged various fees and expenses for the administration of the plan, your account, and your investments inside the account.

What is the strategy of reaching the maximum contribution limit to a 401k early in the year?

Front-loading

Highly compensated employees are often referred to as ...

HCEs

How much do you have to earn to qualify as a "highly qualified employee"?

If you earn less than $85,000 and you don't own more than 5% of your company, you aren't highly compensated. You may be considered highly compensated in a given year if you own more than 5% of your company in that year or the previous year. You may be considered highly compensated in a given year if you earn more than a specified salary in the previous year.

Congress approved what extra tax break to encourage low- and moderate-income earners to save with 401ks and other retirement accounts?

If you're single and have taxable income of $25,000 or less, or if you're married and have joint taxable income of $50,000 or less you can claim a "non-refundable tax credit".

In reality, you can't do what with this new limit (of 100% employee/employer contribution)?

In reality, you can't contribute a full 100% even if your employer doesn't make any contributions, because you must pay Social Security taxes, and possibly state and local taxes, on your income before making your 401k contributions.

Does the Safe Harbor 401k require discrimination tests?

It does not require discrimination tests.

Union employees are excluded from 401k plans why?

Labor laws require union employees who want a 401k to include it in their contract demand. Besides, union managers often prefer traditional defined-benefit pension plans anyway

Why are leased employees excluded from 401ks?

Leased employees are people who work for a company temporarily, often placed through an agency.

What is "employer matching contributions"?

Money that your employer will contribute to your 401k if you contribute to the plan.

What happens if your plan fails the nondiscrimination test during any year?

Refunds will probably be maid.

When you enroll in your 401k plan, you'll need to fill out a "salary deferral" agreement. What is a salary deferral agreement?

Salary deferral refers to the amount of your pay that you want

Small plans with fewer than 100 participants will most often be charged what fee?

Sometimes a 401k plan provider charges what is known as a "wrap fee".

Besides the "federal dollar limit for pre-tax salary deferrals", what is the other limit to be aware of?

The "percentage-of-pay limit". This limit applies to all contributions made to your 401k by you and your employer, as well as to all contributions to other defined contribution plans (such as profit-sharing plans or 403b plans). THese contributions can't total more than 100% of your pay, or $40,000, whichever is less The 100% of pay limit includes catch-up contributions, but the $40,000 dollar limit does not.

What should I know about having "unrestricted access to plan assets after I reach age 59 and 1/2"?

The amount withdrawn becomes part of my taxable income for that year ...

Under federal law, employers must test their plans each year to ensure that no "discrimination" exists in favor of highly paid employees. How do employees go about testing discrimination for a 401k plan?

The contribution percentages of highly paid employees are added up as one group, and the contribution percentages of lower-paid employees are added up as a second group. The average contribution percentage of the highly paid employees can't be more than 2% points above those of the lower-paid group.

What does it mean when 401k has a tax deferral thing?

The gains in your 401k aren't taxed annually, as they would be in a regular taxable bank savings account, a personal mutual fund account, or brokerage account. With a 401k, you defer paying taxes on your investment earnings until you withdraw the money.

What are institutional funds?

These are geared toward traditional pension plans or other entities with large amounts to invest.

What do you mean about "specific categories of employees" are excluded from a 401k plan?

Under certain circumstances, an employer ma exclude a specific category of employees, such as hourly workers or the employees of a specific business unit, from participating in the 401k plan. Finally, you may be excluded if you're under 21.

Under the new federal tax laws, the combined employee/employer limit is what?

Under the new federal tax laws, the combined employee/employer limit is 100% with a $40,000 maximum.

What are "Safe Harbor 401ks"

We'll go into more depth later but this type of plan DOES NOT have to pass certain federal nondiscrimination tests that are part of the law governing 401ks.

Because your 401k is "portable", you can do what?

You can build up a retirement nest egg even if you change jobs fairly frequently. This beats the traditional defined-benefit pension plan in which you receive a set amount from your employer each month in retirement, if you qualify. What is mentioned above is risky because you can lose ALL retirement benefits if you don't work at the company for the minimum vesting period.

What happens when you claim a non-refundable tax credit?

You can subtract a percentage of your contribution to your 401k from your tax bill, as well as lower your taxable income, by making the contribution.

Some plans allow you to make "after-tax contributions". Why might that be beneficial?

You don't get the initial tax breaks of lower taxable income, but you do benefit from deferring taxes on your investment earnings.

What is "graduated vesting"?

You must go from 0 to 100% vested by increases of 20 percent over a period of six years, at the most.

If you earn enough to qualify as a "highly compensated employee", what happens?

Your contributions to your 401k plan may be limited only to a few percent of your salary.

When your employer throws in some extra money for your 401k, what is it called?

a MATCHING CONTRIBUTION.

Your employer may permit withdrawals only for reasons ...

approved by the IRS.

By law, your spouse automatically receives your 401k when you ...

die. Regardless of whom you named as your beneficiary, unless your spouse signs a "benefit waiver" that is witnessed by a notary or plan representative.

There's no "right" amount of fees to pay -- although, if you're paying more than 1% of your account balance, then you're ...

probably paying too much.

Mutual funds that aren't sold to the general public aren't required to ...

provide a fund prospectus. Getting straight answers on fees for these funds can be very difficult.

Wrap fees explain why ...

the return that you see printed in the newspaper for the funds you invest in may be different from what you see on your 401k statement. 1.5 may not seem like a lot but it reduces your 30-year savings by 30%

To be blunt, if you think there's a chance you won't stay married ...

you may be better off continuing to fund your own 401k to the extent possible rather than putting some of your money toward your spouse's 401k plan.

A 401k is only available through ...

your employer

Employer matching contributions generally become yours to keep either...

1. All at once on a specified date within 3 years. or 2. Gradually over 6 years.

What are the two broad categories of retirement plans?

1. Defined benefit plans. 2. Defined contribution plans.

Under this new federal tax law, who benefits with this 100% employee/employer limit?

1. Low-income savers 2. People who start a career after earning a military, police, or other pension

What are the ERISA requirements?

1. Provide information to you about plan features on a regular basis. Like a summary plan description. 2. Define how long you may be required to work before being able to sign up for the plan or before employer contributions to the plan are yours to keep if you leave your job. 3. Detailing requirements for the "plan fiduciary", essentially including anyone at your company or the plan provider who has control over the investment choices in the plan.

Which employees can be excluded from a 401k plan?

1. Union employees covered by a collective bargaining agreement 2. Nonresident aliens 3. Leased employees 4. Specific categories of employees.

The federal law allows three ways to get money out of your 401k while you're working for the employer sponsoring the plan. What are these three ways?

1. Unrestricted access to plan assets after you reach age 59 1/2. 2. Withdrawals for financial hardships as defined by law and IRS regulations. 3. Plan loans

What are the two cases that make your 401k vulnerable in the case that you declare personal bankruptcy?

1. When you owe money to the IRS. 2. If the court mandates you to give money to your ex-spouse as part of your divorce settlement.

Transferring your money to a new employer's plan or an IRA is known as what?

A "rollover" or "trustee-to-trustee transfer".

What exactly is a 401k?

A 401k plan lets you put some of your income away NOW to use LATER, presumably when you're retired and not earning a paycheck.

In times of hardship, evaluate whether a hardship withdrawal is worth it. What are some alternatives to hardship withdrawals?

A LOAN YOU MORON

Instead of investing money in after-tax contributions for your 401k, what other option should you consider?

A Roth IRA because you can make after-tax contributions to a Roth but you pay no income tax when you withdraw the money at retirement.

If you earn more than the HCE salary limit, you still may not be considered an HCE even if your company has a lot of highly paid employees. How so?

A company is allowed to limit its designated HCEs to only the top 20% of employees. This flexibility doesn't exist with the ownership rule, though.

What is "cliff vesting"?

Cliff vesting is where you received all of your employer 401 contributions on a specified date within 3 years. You go from 0 to 100% vested after you have earned three years of service, at the most (the period can be shorter).

What is the prospectus?

It is a document that tells you things such as what companies the mutual fund invests in, how often the manager buys and sells stocks within the fund, and what the manager is trying to achieve (the fund objective). It also includes the expense ratio.

What is the 401k named after?

It is named after the section of the IRS "rulebook" that governs how it works.

What is the federal dollar limit for pre-tax salary deferrals?

It is the cap on how much income you can have your employer put into the 401k rather than the paycheck.

What is an "investment election form"?

It is this form where you need to decide where to invest your money. The percentages on your investment election form must add up to 100%

Many people wonder whether their 401k money is at risk if their employer goes belly-up (bankrupt). What is the answer?

The answer is usually no, with a few caveats (exceptions).

SIMPLE 401K plans are disappearing though, why?

The introduction of Safe Harbor 401k in the late 1990s also have fewer administrative requirements but allow for higher contribution limits. Most employers have switched away from the SIMPLE 401K.

How does a 401k contribute to a "lower taxable income"?

The money that you contribute to your 401k reduces your "gross income" or "taxable income" (your pay before tax and any other deductions). When you have a lower taxable income, you pay fewer taxes (such as federal, state, and local government taxes).

What are the potential problems of front-loading?

The potential problem with this strategy is that it can cause you to lose some of your employer match. Ask your employer about its timing for depositing matching contributions.

What happens if you don't name a beneficiary or if the beneficiary you name isn't living when you die.

The provisions in the plan document determine who gets the money.

What are "retail mutual funds"?

These are available to the average individual investor. They are more likely to be expensive in a 401k plan than an "institutional fund".

What happens to the vesting period if the employer contribution is NOT matching contributions but profit-sharing or automatic contributions?

These may take LONGER to vest. The maximum requirement for cliff vesting is 5 years. The maximum requirement for graded vesting is 7 years.

What is a "beneficiary designation"?

This is where you list the person or people whom you wish to receive the money in your account if you die. A will or trust won't control distribution of the 401k.

What is "vesting"?

You typically have to work for your employer for a certain period of time before you can leave the company without forfeiting (losing) your employer's contributions.

If you're married, you and your spouse should contribute the maximum amount required to get the full match in your plans. If you can't afford to do so ...

you may want to see which plan has the higher match and best vesting schedule.

If you lose most of your money because you make bad investment decisions or the stock market takes a nosedive, but your employer has followed ERISA rules, ...

your employer is off the hook.

What are the different types of defined contribution plans?

1. 401k 2. 403b 3. 457 "deferred comp" 4. Defined contribution/money purchase pension 5. Employee stock ownership plan (ESOP) 6. Stock bonus plan 7. Simplified Employee Pension (SEP) 8. Profit-sharing 9. SIMPLE IRA

Many 401k plans offer at least ten investment choices. Ideally, the minimum your plan should offer is ...

1. A large-company stock fund 2. A small-company stock fund 3. A bond or other fixed-income fund 4. A money market (cash) fund 5. A mutual fund that invests in international stocks and/or bonds

When are the times when your money in a 401k account is at risk if your company goes bankrupt?

1. If the money is in investments that are tied to your employer (such as a company stock), and the employer goes bankrupt, you may lose your money. 2. In the case of fraud or wrongdoing by your employer or the trustee of the 401k account, your money may be at risk. 3. Part of your money may be lost if your employer goes out of business or declares bankruptcy before depositing your contributions into the trust fund that receives the 401k money that is deducted from your paycheck.

What exceptions are there for immediate vesting of matching and non-matching employer contributions, no matter how many years you may have worked at the company?

1. If your employer terminates your 401k plan. 2. If you reach "normal retirement age" (this is defined by the plan, but it is usually age 65). 3. If you die before you leave the company. 4. If you become disabled, as defined in the plan. 5. If you're among a "substantial portion" (such as more than 20%) of plan participants who are laid off due tot he closing of a plant or division, or are otherwise part of a large layoff.

A 401k plan allows you to pay less income tax in which two ways?

1. Lower taxable income. 2. Tax deferral.

When you change jobs, you can take your 401k money with you and keep the tax advantages by doing what?

1. Putting it into your new employer's 401k, 403b, or 457 plan. 2. Put it into an IRA account

What are the four common types of services, for which fees may be charged, that you are likely to receive in your 401k?

1. Recordkeeping and other administrative functions. 2. Investment management. 3. Benefit transactions 4. Education and advice

What are the two types of pre-tax contribution limits?

1. Regular contribution (Under 50) 2. Catch-up contribution (Over 50)

What are the taxes that you can't avoid because everybody has to pay them on gross income (including 401k contributions)?

1. Social Security & Medicare (FICA) 2. Unemployment (FUTA)

What are there administrative costs to 401k plans?

1. Someone has to do the number crunching and recordkeeping. 2. Other bullcrap

401k plan fees can be tricky to understand because of the way plans are put together. Generally, there are what though?

1. You have fixed administrative cost 2. You have variable costs associated with individual investment choices.

Most 401k fees are expressed in "basis points". What are basis points?

100 basis points equals 1%. How much is 150 basis points? 1.5%

How is money in a 401k plan protected in some ways that money in an ordinary savings account, IRA, or brokerage account isn't?

401k plans are governed by a federal law called ERISA, which sets minimum standards for retirement plans offered by private sector companies.

A few smalll businesses may offer what?

A "SIMPLE 401k" plan.

Some companies offer a "brokerage window", what is that?

A brokerage window lets you investing in individual stocks and bonds in addition to the mutual funds offered by the plan. Think of it as a "window" to a larger universe of stocks, bonds, and mutual funds.

How can an employer change its contribution formula?

After an employer sets the formula for the matching contribution, it must meet the commitment until it amends the "plan document" (the official document detailing the plan's rules) with a new formula.

A small number of 401k plans allow "after-tax" contributions. What are after-tax contributions?

After-tax contributions are contributions where you cannot deduct them from your income tax ... but you can still benefit by having them grow tax deferred. Tax deferred is where they won't be taxed for capital gains every year.

What's the catch to the catch-up contribution?

Although federal law allows this type of contribution, your plan has to change its rules specifically to allow catch-up contributions before you can make them. Your plan isn't required to allow these contributions.

Why is it that highly compensated employees are limited only to a few percent of their salaries?

Because 401k plans are REQUIRED to pass a "nondiscrimination test" each year to make sure that highly paid employees as a group aren't contributing a lot more to the plan than their lower-paid colleagues. Congress is looking out for the little guy when performing these tests.

Why did Congress approve of the catch-up contribution?

Congress approved this extra tax break to help workers who may not have contributed much to their own retirement savings early on, particularly women who may have stepped out of the work force to raise children or care for ailing relatives.

What are "defined benefit plans"?

Defined pension plans are traditional pension plans in which the amount you receive (the benefit( is "defined" up front based on factors such as your salary in your final year (or years) of your career with your company. Your employer is responsible for making sure that there's enough money in the plan to pay for this benefit. There are fewer and fewer of these now.

When you invest a specified amount at regular intervals, as you do with automatic 401k contributions from your paycheck, you are using an investment strategy called what?

Dollar cost averaging.

Why are 401k plans like snowflakes?

Each one is unique. Federal laws govern many aspects of 401k plans, but employers are allowed to be more restrictive with their plan rules.

Employers can do what regarding schedule and depositing contributions?

Employers can choose their own schedule for depositing contributions into your account. Some may do this every pay period, while others may deposit a year's worth in one shot. The contributions can be deposited at any time until the tax-filing deadline for that year, including extensions.

When you declare personal bankruptcy, what happens to your 401k?

Federal law says that if you declare personal bankruptcy, your creditors can't touch your 401k. But they may be able to get at your other savings, but your 401k should be protected.

Can you go into fidelity bonds a bit more?

Fidelity bonds generally cover 10% of the amount in the entire plan, or $500,000, whichever amount is smaller.

Give me an example of someone benefiting from this new federal tax law limit.

For example, if you retired from the military with a pension that covered most or all of your everyday expenses, but you become bored and decided to go back to work part-time earning $14,000, you could contribute $11,000 of this amount to a 4001k.

Who is Ted Banna (the author of this book)?

He is commonly referred to as the "father of the 401k" because he created and gained IRS approval for the first 401k savings plan.

Most employers do what to deal with the 401k plan administrative functions?

Hire outside firms. The plan provider (the financial company that offers your plan's investments, such as Fidelity or Vanguard) also handles the administration.

What is "variable or discretionary matching contributions?

It is a hybrid of profit-sharing and matching contributions. You have to contribute to your 401k to get it, as with an ordinary matching contribution, but the amount of the contribution VARIES at the DISCRETION of your company. For example, the amount of your matching contribution may depend on the success of your company from one year to the next.

When judging the quality of funds offered in your plan, what is something important you should remember?

It is impossible for employers (or anyone else, for that matter) to pick consistently top-performing fund options in each category. What's more, funds that can boast top short-term performance records may not even be the best choices for long-term investors in a 401k plan.

What is a big benefit of signing up for your 401k plan?

It is that you don't have to think about the fact that you're saving. "Out of sight, out of mind" is what happens to most people -- they don't even miss the money, because it's taken out of their paycheck before they have a chance to spend it.

What is a "non-matching contribution"?

It is when the employer contributions to the employee's 401k whether the employee contributes or not. A company may also make a non-matching employer contribution that is not based on the company's financial results.

What is fiduciary responsibility?

It means that anyone who has a decision-making role in your 401k plan's investments is legally bound to make those decisions in the best interest of the plan participants and not in the best interest of the company, the plan provider, or the fiduciary's cousin Joe.

What is a catch-up contribution?

It raises your pre-tax contribution limit

Many employers permit you to borrow money from your 401k but not necessarily for any old reason. In times of hardship, you can do what?

Many plans permit "hardship withdrawals", which are withdrawals from your account to pay expenses when you're in financial difficulty.

Most plans let you decide how to invest your money among what?

Most plans let you decide how to invest your money among the options offered. A very small number of plans DO NOT let you choose how the money is invested -- the employer decides for you. In this case, the employer has greater fiduciary liability for the account's investment performance.

The 401k plan set up by your employer provides you with choices for how to invest your money. Most 401k plans limit these choices to what?

Mutual funds.

Does the maximum pre-tax contribution limit apply to employer matched contributions?

No! The limits only apply to YOUR pre-tax contributions and do not include contributions from your employer. These same rules apply for a 401k and 403b plans. However, with a 457 plan, the employer contribution DOES count toward these limits.

Your employer may gain limited protecting through something called what?

Something called 404(c). Without going into too much detail, Section 404(c) of ERISA requires your employer to provide you with specific information about the investment options, and to allow you to make changes in your investments frequently enough to respond to ups and downs in the market. In return, you assume liability for your investment results.

How much can I contribute to my 401k?

There is a limit and that limit varies. It depends on your age and it depends on the government. The government can revise the laws regulating 401ks each year.

What are "defined contribution plans"?

These include 401ks and similar plans in which the contributions to your account are "defined" by you and your employer. Your eventual benefit depends on how much is contributed and how well your investments do.

What are SIMPLE 401k plans?

These plans have fewer administrative requirements for the employer, but the trade off is lower contribution limits. SIMPLE stands for Savings Incentive Match Plan for Employees There is also the SIMPLE IRA

Should you be worried about fraud or wrongdoing by your employer or the trustee of the 401k account?

These situations are rare. What's more, your employer is required to buy a type of insurance called a "fidelity bond". A fidelity bond may enable you to recoup at least some of your money in the event of dishonestly.

Why does the government provide these big tax breaks in the form of a 401k? What is the purpose?

They allow these tax breaks in an attempt to avoid having a country full of senior citizens who can't make ends meet.

What should I know about "hardship withdrawals"?

They are fully taxable and are usually subject to an additional 10% federal early withdrawal penalty (and possibly additional state and local penalties as well).

What is the most common formula for employers to use when it comes to employer matching contributions?

They put in 50 cents for every dollar you contribute up to 6 percent of your salary.

Statistically, how common are each of these vestings?

They're roughly equal to be honest. 1/3 - Has "immediate vesting" where you don't have to wait at all 1/3 - Has graduated vesting 1/3 - Has cliff vesting

What is dollar cost averaging?

This investment strategy may lower the average price that you pay for your investments. Because you're spending the same amount each time you invest, you end up buying more shares of your investments when prices are low and fewer shares when prices are high. By averaging high and low prices, you reduce the risk that you will buy more shares when prices are high.

Some 401k plans may not allow you to do what?

Withdraw money while you're still working.

Before the new tax law went into effect in 2002 (EGTRRA - the Economic Growth and Tax Relief Reconciliation Act), your contributions what? ...

Your contributions (pretax & after-tax) combined with your employer's contributions could be more than 25% of your pay or more than $35,000 or whichever figure was smaller. As a result, employers had to limit the percentage of pay that you could contribute. For example: You would contribute 20% while your employer contributed 5%.

When it comes to your 401k investment choices, who generally makes the decisions?

Your employer chooses the investment options that will be offered by the plan. Generally, these are mutual funds and, possibly, stock in your employer's company.

What happens exactly when you sign up for a 401k plan with your employer?

Your employer deposits some of your paycheck into the plan as PRE-TAX CONTRIBUTION, instead of paying it to you.

What is the exception to the three ways you can withdraw money from a 401k?

Your employer isnt' required to allow these features, so they may not be available in your plan.

What could be the most single important feature in a 401k plan?

Your employer matching contribution!!!!! The more you get from your employer, the less you have to save out of your own paycheck.

What are one example of a non-matching contribution?

Your employer may deposit a profit-sharing contribution into the 401k on your behalf, either alone or in addition to a matching contribution.

What is the footnote to this new employee/employer limit?

Your employer must modify its plan before you can contribute a higher percentage.

When it comes to administrative fees, who pays? You or the employer?

Your employer pays usually during the first few years after starting a plan. Employers commonly shift payment of the administrative fees to you, the participant, as the plan matures.

What is easier to withdraw theoretically, your contributions or your employer's contributions?

Your employer's contributions. Theoretically, federal law makes it easier to withdraw your employer's contributions while you're working. Your employer may allow you to take the employer contributions out for any reason. But most employers place restrictions on withdrawals of their contributions because they want you to use the money for retirement.

In most states, you aren't required to pay state or local taxes on contributions to your 401k. However, ...

a few states may require you to list all or part of the money that you contribute to a 401k as taxable income on your state tax return.

If you're looking for a standard 401k plan, ...

be aware that there's no such animal. Each company creates its own plan, and SOME ARE BETTER THAN OTHERS.

If you do manage to withdraw your money using a hardship withdrawal before you turn 59 1/2, you'll ...

you'll be heavily taxed. Not only will you owe federal and perhaps state and local income tax on the amount withdrawn, you'll also owe a 10% federal early withdrawal penalty on the entire amount. Some states may also impose additional early withdrawal penalties of a few percent.