I am thinking of taking a 401K withdrawl to help my daughter get a good start from college... by paying off her loans. I believe that these expenses exempt the withdrawl from the 10% penalty. Is that true? I have all of the expenses from the 4 years she was in school and also her cost for a masters, which she is working on now. How often and how closely is this type of action audited? Do I have to be perfect with it... to the penny?

You don't mention whether you are an active employee at the company where the 401(k) is located, or whether you are under age 59-1/2. So for sake of discussion I will assume that both of these conditions are true.

Plans differ, so you'll have to ask your 401(k) plan administrator what the rules are, but most plans allow active employees to make withdrawals only for the "hardship" purposes as defined by IRS rules, which means you are facing a "heavy and immediate" financial burden after you've exhausted other possibilities. One of those hardships is using the money for "payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for the employee, or the employee's spouse, children, or dependents." Note that this does not cover paying off student loans - this is not considered a "hardship" by the IRS. So in all likelihood your 401(k) plan will not allow you to make a withdrawal for this purpose. Further, unless you've already maxed out any loan provision in your plan you have not exhausted all other possibilities, so again you would probably be denied.

As for the 10% penalty - if they did allow to make a withdrawal for this purpose, it would in fact be subject to the 10% early withdrawal penalty, even though the term "hardship" is used in defining its purpose.

Finally, as to how they "audit" that the money is used for the purpose you claim - they would require you to submit a bill showing the tuition owed, and I believe the distribution check would be made out to the school, not to you.