- Withdrawing money from your 401(k) early usually involves additional taxation and penalty fees.
- There are ways to avoid the 10% penalty, including 401(k) loans and hardship withdrawals.
- While withdrawing early from your 401(k) might be enticing, it can be detrimental in the long run.
When you deposit into a 401(k) plan, one of the best retirement plans for building long-lasting wealth, you're putting that money away for your future self to live on. But what happens if you need that cash now?
The good news: You can access your 401(k) funds before you turn 59 ½ through a process the IRS calls an "early withdrawal." The bad news: An early withdrawal usually triggers a steep penalty in addition to taxes. You will also lose out on years of potential growth for your nest egg.
That said, you may avoid extra fees and taxes with specific penalty-free withdrawal strategies and qualifying exceptions. Here is what you need to know about prematurely withdrawing from your 401(k) plan in 2024.
Understanding 401(k) withdrawal rules
What is a 401(k) plan, and when can you withdraw?
A 401(k) is an employer-sponsored retirement plan. You make regular pre-tax contributions to it – that is, straight off the top of your paycheck — and the money within it grows tax-free. The money is taxed as income when withdrawn during retirement.
Many employers also offer Roth 401(k) plans, funded by after-tax dollars, for tax-free growth and withdrawals. Roth 401(k) plans have the same contribution limits and withdrawal rules as traditional 401(k) plans.
Because these tax-advantaged accounts are meant to help you save for retirement, the IRS imposes strict rules about when and how you can withdraw your money. You must be at least 59 ½ and a half years old to withdraw from your 401(k) plan without penalty.
If you withdrawal from your 401(k) before you're 59 ½, you'll be subject to:
- A mandatory 20% federal tax: When you take out money, the plan's service provider must withhold 20% in federal income tax. That means if you withdraw $10,000, you will get $8,000. While you will get this back as a tax refund if the money withheld exceeds your tax liabilities, this will significantly cut into the money that, presumably, you need immediately.
- A 10% tax penalty: You will owe a 10% penalty when you file your income tax return — or $1,000 on that $10,000 withdrawal.
A 401(k) early withdrawal will cost you more than 30% of your withdrawal amount.
For example, say you withdraw $20,000 when you're 40. Assuming a 7% annual rate of return, the potential future value of that $20,000 today would be nearly $110,000 by the time you're 65. Even if you pay yourself back as you would with a 401(k) loan, you won't be able to make up for the lost time the funds weren't growing in your account.
Avoid the 10% penalty fee on early 401(k) withdrawal
In most cases, you'll just have to take that 10% penalty if you decide to withdraw from a 401(k). But the IRS will waive that 10% penalty in extenuating circumstances, such as:
- Permanent physical or mental disability
- Dividing assets in a divorce with a former spouse or dependent
- Qualified military reservist within 180 days of active duty
- Retiring, quitting, or getting laid off from your job with the rule of 55
- Enrolling in substantially equal periodic payments
Thanks to the Secure Act of 2022, you can withdraw up to $1,000 per year without penalty if you use the money for personal or family emergencies. You must repay the money within three years, and you can't take out another emergency distribution until you pay back the full amount.
Alternatives to 401(k) early withdrawals
Consider a 401(k) hardship withdrawal
The IRS allows anyone to take penalty-free withdrawals if they have an "immediate and heavy financial need." You can use the money to cover your needs or someone else's. You may qualify for a 401(k) hardship withdrawal if the funds go to:
- Pay for certain medical expenses
- Buy a primary residence (excluding mortgage payments)
- Cover college tuition, fees, room, and board
- Prevent eviction or foreclosure
- Pay for burial and funeral expenses
- Make necessary home repairs after a disaster
The amount you can withdraw will be limited to the amount required to cover the expense.
Take out a 401(k) loan instead
Given all the drawbacks of early withdrawals, you might consider borrowing from your retirement savings with a 401(k) loan.
Generally, you can borrow up to $50,000 or 50% of your vested account tax-free if you repay the loan within five years. If you leave your job, you may be expected to pay off the loan quickly. A 401(k) loan can be a better option than an early withdrawal for a couple of reasons:
- You won't owe taxes or a penalty on the amount you borrow unless you violate the loan limits and repayment rules.
- If you repay the loan on time, you won't miss out on years of growth like you would with a withdrawal.
- The interest you pay on a 401(k) loan can return to your 401(k).
That said, some 401(k) loan plans don't let you contribute to retirement while you have an outstanding balance. Additionally, the money you use to repay the loan is already after-tax income. This money will be taxed again once you take it out after you've retired.
Enroll in substantially equal periodic payments (SEPP)
Enrolling in a Substantially Equal Periodic Payments (SEPP) plan can avoid early withdrawal penalty fees. With SEPP, you withdraw a specific amount from your 401(k) every year for five years or until you turn 59 ½, whichever comes later. You can set up a SEPP plan through a financial advisor or financial institution.
However, there is one catch: The 401(k) account can't be the one you have at your current job — it has to be one you've kept from a previous employer. Also, if you quit the SEPP plan early, you'll owe all the penalties plus interest.
Convert your 401(k) into an IRA
To avoid paying a 401(k) penalty when you leave your job, you could roll your 401(k) into an IRA. With a 401(k) rollover, you won't pay a penalty. But depending on which types of accounts you have, you might pay taxes.
If you roll a traditional 401(k) into a traditional IRA, you won't pay taxes because both accounts are tax-deferred. Similarly, you won't pay taxes if you roll a Roth 401(k) into a Roth IRA because both accounts use after-tax dollars. But if you roll a traditional 401(k) into a Roth IRA, you'll have to pay taxes on the amount you rolled over.
401(k) early withdrawals during a recession
A recession spells bad times for everyone. Gross domestic product (GDP) falls, industrial production slows down, and, most noticeably, unemployment rates rise. With dwindling savings, you may find yourself on the wrong side of that trend. You have a nice amount of money you set aside for a future version of yourself.
Many people follow through on this tempting idea. A 2013 study from the IRS found that in 2004, before the Great Recession, 13.3% of people with some retirement plan experienced a taxable retirement account distribution—essentially an early withdrawal. That percentage rose to 15.4% in 2010.
An early withdrawal should be a last resort. If you can afford not to withdraw early, do so. However, like many other issues within personal finance, recessions impact income levels differently. The same survey states that lower-income households have a higher propensity for an early withdrawal because the economic shock more deeply affects them.
FAQs
When can I withdraw from my 401(k) without penalties?
You can withdraw from your 401(k) without penalties starting at 59½. Withdrawals before this age often incur a 10% early withdrawal penalty unless an exception applies. Some exceptions for early withdrawals include hardship situations, disability, and enrolling in substantially equal periodic payments.
What are the exceptions to the 10% early withdrawal penalty?
Exceptions to the 10% early withdrawal penalty include qualifying hardship withdrawals, medical expenses, disability, substantially equal periodic payments (SEPP), and withdrawals after leaving a job at age 55 or older (the rule of 55).
What are Required Minimum Distributions (RMDs)?
Required minimum distributions (RMDs) are mandatory withdrawals beginning at 72 or 73, depending on your birth year. Your minimum withdrawal amount is based on your account balance and life expectancy. Failure to take your RMDs can result in hefty penalties.
How are 401(k) withdrawals taxed?
Withdrawals from a traditional 401(k) are taxed as ordinary income when you withdraw the funds during retirement. That means you won't pay tax when you contribute the money to your 401(k) plan. Federal and state taxes may still apply. If you have a Roth 401(k), you fund your account with after-tax dollars for a tax break later in retirement.
Can I withdraw from my 401(k) while still employed?
Some plans allow in-service withdrawals or loans from your 401(k) while you are still employed, but you will likely still be charged additional fees and taxes. Check with your plan administrator to understand the specific rules and options available with your specific 401(k) plan.
