There are ways to withdraw funds early from retirement plans like your 401(k) without getting hit with a tax penalty.

The rules are a bit rigid and, from a long-term perspective, you should think carefully before taking money out of your retirement plan until you're retired. In most cases, it's not the best strategy. Nonetheless, it can be done.

First, you need to know the rules. Distributions from employer-sponsored retirement plans and individual retirement accounts (IRAs) are subject to a 10% penalty if you start withdrawing the funds before you reach age 59 1/2.

Getting At The Cash, Avoiding The Pain
There are other options to get at your cash without getting penalized in the process:

1. Take the money as part of a series of substantially equal periodic payments over your estimated lifespan or the joint lives of you and your designated beneficiary. These payments must be made at least annually, and you base the payments on life expectancies from IRS tables. (See IRS Publication 939: General Rules for Pensions and Annuities.) If payments are from a qualified employee plan, they must begin after you have left the job.

   The payments must be made at least once each year until age 59 1/2, or for five years, whichever period is longer.

2. If you have extraordinary out-of-pocket medical expenses one year and your medical expenses exceed 7.5% of your adjusted gross income, you can withdraw funds to pay those expenses without paying a penalty. For example, if you had an adjusted gross income of $100,000 and medical expenses of $10,000, you could withdraw as much as $2,500 from your pension or IRA without incurring the 10% penalty tax.

3. An IRA distribution for first-time home purchases also escapes the penalty. You need to understand the government's definition of a "first time" homebuyer. In this case, it's defined as someone who hasn't owned a home for the last two years prior to the date of the new acquisition. You could have owned five prior houses, but if you haven't owned one in at least two years, you qualify.

   The "date of acquisition" is the day you sign the contract for purchase of an existing house or the day construction of your new principal residence begins. The amount withdrawn for the purchase of a home must be used within 120 days of withdrawal and the maximum lifetime withdrawal exemption is $10,000.

4. Distributions for qualified higher educational expenses also are exempt. Such expenses as tuition, room and board, fees, books, supplies and equipment required for enrollment are all covered. So, too, are expenses for graduate courses. This exception applies to expenses incurred by you, your spouse, children and grandchildren.

5. IRA distributions made to unemployed individuals (unemployed for more than 12 weeks) for health insurance premiums aren't subject to the 10% penalty tax.

6. If you receive a distribution due to "separation from service" (you're no longer at the job) in or after the year you reach age 55, you escape the penalty. This exception doesn't apply to distributions from IRAs or annuity or modified endowment contracts.

7. Distributions due to your death or due to total and permanent disability also avoid the 10% penalty tax. This is not a tax-planning strategy I personally advocate.

Remember that the above techniques avoid the 10% penalty tax, but they don't avoid the regular income tax that's owed when you start withdrawing funds from your retirement plans. Unless your money is parked in a Roth IRA -- which is after-tax contributions -- you're going to pay a tax.

Distributions rolled over into another retirement plan or arrangement however, escape both the regular income tax and the 10% penalty tax. Such rollovers should be made directly between your brokers. That way, you even escape the 20% withholding required on distributions that you touch.

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