Obama's Broken Promise? 401(k) Penalties Persist

This provision permits employees who leave a company in the year they turn 55 or later to make penalty-free withdrawals from a 401(k) or other qualified retirement plan. If they leave before then -- say at age 53 -- they can't wait until age 55 and then begin withdrawing.

The "separation from service," as the IRS puts it, must occur at age 55 or over, or in the calendar year you turn 55. For public safety workers, the age threshold under this provision is 50.

For older, laid-off workers who would qualify, this could be a reason to keep your retirement funds parked in the 401(k) account rather than moving them to an IRA.

For younger workers, however, moving the funds to an IRA might be the better option. With an IRA, there's no employer or hardship requirement to block an early withdrawal if you're willing to pay the 10 percent penalty.

Also, an IRA allows for penalty-free, early withdrawals in limited circumstances, such as covering higher education expenses and first-time home purchases.

Penalty-Free Withdrawals in the Future?

If you feel you must withdraw from your retirement accounts to survive the current turmoil, take a close look at IRS publications 575 and 590, which outline the various penalties and exceptions that pertain to IRA, 401(k) and other retirement accounts.

My advice is to avoid these moves if at possible, but I understand these are the toughest economic times many of us have ever lived through.

That's why I believe the longer the current economic turmoil lingers, the higher the likelihood that penalty-free withdrawals from retirement accounts will be allowed. There's recent precedent to think this might happen.

Over the past few years, Congress has approved special legislation that allowed such measures for military reservists called to active duty, and taxpayers affected by hurricanes Katrina, Rita and Wilma and tornadoes in Kansas and elsewhere in the Midwest.

For instance, homeowners and workers hurt by a series of tornadoes and storms that struck Kansas May 4, 2007, could withdraw up to $100,000 from retirement plans without penalty if it was done before the beginning of this year. Those distributions were still subject to income tax, but taxes could be spread out over a three-year period.

If the current economic storm lingers, don't be surprised if we see more of this coming out of Washington.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.

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