Question

What is the reason that there are tax penalties associated with individuals taking withdrawals from their 401(k) plans prior to age 59.5? What is the reason that there are tax penalties for NOT taking withdrawals prior to age 72?

Answer 1

The purpose of 401 (k) plans is to provide a security after a person attains retirement, so that when he is unemployable he doesn't have to suffer then.

Therefore, withdrawing before the age of 59.5  (which is very near to retirement) there is a penalty because otherwise people will start withdrawing funds for expenses or some crisis like if they lose their job for a month, effectively reducing their life long savings. This funds provide huge rate of compounding interests and removing the funds just to cover for expenses may cost a lot more to the person in his retirement.

In order to avoid such practices there is a penalty of 10%. However, the law also provides some exception to the withdrawl if its for "Hardship" that covers higher education, first time house and health insurance premium, wherein, you don't pay such penalties.

Coming to second part,

The IRS requires a person to withdraw after they attain a age of 70.5 years, called Minimum Required Distribution. If such withdrawls are not made by the time you're 72 then you'll have to pay huge penalty (as high as 50%)

Why they have kept it? Because IRS wants a percentage of your Income. As we know 401(k) is tax deffered reteriment saving plan, so if the person doesn't withdraw any money while he is alive (from a fund created to help him live his retirement), the whole sum may be withdrawn by its legal heirs without any tax liabilities on the money earned by the person once through his income and investment gains. Thus, it gives IRS an opportunity to deduct their share.

And secondly as mentioned, these are highly interest paying compounded securities, so the investment gains will be high but at the same time its tax deferred, and thus IRS has implemented this, so that if the money goes to inheritance, the state gets its share, as the purpose of 401 (k) is to meet the living expenses of retired persons which was not served.