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If your employer allows it, getting money from a 401(k) plan before age 59½ is possible. However, early withdrawals deplete retirement savings permanently and, minus a few exceptions, carry a 10% penalty and an income tax bill. Your company’s human resources department can help you explore your options.
Key Takeaways
- If you withdraw money from a 401(k) plan before age 59½, you may incur a 10% early withdrawal penalty along with income taxes on the distribution.
- The IRS allows certain exceptions to the penalty, such as for medical bills and natural disasters.
- You may qualify for a hardship withdrawal for certain expenses, but you will still owe the 10% penalty unless it meets one of the exceptions.
- Even if the IRS permits an early distribution, your 401(k) plan may not, so check your plan document for specifics.
Penalties for Early Withdrawals
Withdrawing money from a 401(k) early means you will owe income taxes on the distribution along with a 10% tax penalty on the amount withdrawn unless it qualifies for an exception to the penalty under IRS rules.
Taking an early withdrawal “really should be your last resort,” says Eric Droblyen, CEO of 401(k) provider Employee Fiduciary. “Once you take that money out, it can’t keep earning compound interest.”
Even though the IRS does allow penalty-free withdrawals in certain cases, those distributions come with a large cost in future retirement income. “If you take a $10,000 distribution now, it could have been $20,000 or $30,000 by the time you retire,” Droblyen adds.
$6,300
The approximate amount you will clear on a $10,000 withdrawal from a 401(k) if you are under age 59½ and subject to a 10% penalty and taxes.
Exceptions to Early Withdrawal Penalty
The IRS permits early withdrawals without a penalty for medical bills, natural disasters, and certain other contingencies. In addition, if you leave or lose your job before age 59½, the age threshold drops to 55.
You may also withdraw up to $5,000 without penalty to pay expenses related to the birth or adoption of a child under the terms of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
Here’s the full list of possible exceptions:
| Exceptions to Early Withdrawal Penalties | |
|---|---|
| Reason | Notes |
| Birth or Adoption | Up to $5,000 per child for qualified expenses |
| Automatic enrollment | Participants can choose to withdraw contributions if they are automatically enrolled in the plan, but must do so by their second pay date (or within 30 days of the first pay date, whichever is sooner) |
| Corrective Distributions | If you exceed contribution limits, you can withdraw the excess without penalty within time limits |
| Death or disability | If the account owner dies or becomes totally and permanently disabled |
| Disaster recovery | Up to $22,000, if you sustain losses because of a federally declared disaster where you live |
| Domestic Abuse | Up to $10,000 or 50% of the account, whichever is lower. |
| Domestic relations | When a marriage is dissolved, a court may order distributions to a former spouse or dependent. |
| Emergency personal use | One distribution per year, up to $1,000 for personal or family medical emergencies. |
| Equal payments | As part of a substantially equal periodic payments (SEPP) plan |
| Dividends | If received through an employee stock ownership plan |
| Levy | If the IRS levies the plan |
| Medical expenses | The amount of unreimbursed medical expenses, exceeding 7.5% of your AGI |
| Military | For qualified reservists called to active duty |
| Rollovers | Within 60 days of distribution |
| Separation | If the employee leaves their job after age 55 |
| Terminal illness | If certified by a physician as being terminally ill prior to the distribution |
Note, however, that even if a distribution is covered by one of these exceptions, it may not be permitted under the terms of your 401(k) plan. Check your plan document to determine what types of withdrawals are allowed.
Hardship Distributions
A retirement plan may also allow early distributions in the event of an “immediate and heavy financial need.” These are called hardship distributions. An employee is automatically considered to qualify for a hardship distribution to pay for the following expenses:
- Medical expenses for the employee or their family (spouse, children, dependents, or beneficiary)
- Purchase of a primary residence (excluding mortgage payments)
- Tuition and related expenses for the employee, their spouse, or their children or dependents
- Payments to prevent foreclosure or eviction
- Funeral expenses for the employee or their family members
- Certain expenses to repair damage to the primary residence
Note, however, that these distributions are limited to the amount needed to cover the financial need, along with any tax they incur. Hardship withdrawals are still subject to the 10% penalty, unless they meet one of the exceptions. In addition, hardship distributions cannot be repaid to the plan or rolled into another tax-advantaged plan.
Important
With an early distribution, you will still owe the income taxes on the distribution even if the penalty is waived. If it’s a traditional 401(k), you will owe taxes on the entire withdrawal. For a Roth 401(k), you’ll only pay taxes on the earnings.
Withdrawal Alternatives
Loan: You can take a 401(k) loan to make an early withdrawal. Essentially, you’re loaning money to yourself, with a commitment to pay it back. A loan allows you to replace the money, which you can do through payments deducted from your paycheck. Check with your employer to see if you’re eligible.
SEPP withdrawals: Substantially equal periodic payments (SEPPs) are an option for withdrawing funds from an IRA without paying the early distribution penalty of a 401(k). Withdrawals are not allowed while working for your employer. If the funds are from an Individual Retirement Account (IRA), you may start SEPP withdrawals at any time.SEPP must be calculated using one of three methods approved by the IRS: fixed amortization, fixed annuitization, or required minimum distribution (RMD).
Do I Have To Pay Back a 401(k) Loan?
Any money not repaid on a 401 (k) loan, plus interest will be considered a plan distribution. Some plans may even require you to repay the entire loan if you leave your job.
How Much Tax Do I Pay on an Early 401(k) Withdrawal?
With a traditional withdrawal, the money will be taxed as regular income, just as it would in retirement. That’s from 10% to 37%, depending on your taxable income. The taxes will be due for the tax year you take the distribution. If your withdrawal does not meet the qualifications for a penalty-free distribution, you will also pay an additional 10% tax.
What Are the Pros and Cons of a Withdrawal vs. a 401(k) Loan?
A withdrawal is a permanent hit to your retirement savings. By pulling out money early, you’ll miss long-term growth. Though you won’t have to pay the money back, you will have to pay the income taxes due, plus a 10% penalty if the money does not meet the IRS rules for a hardship or an exception. A loan against your 401(k) has to be paid back. If the money is repaid on time, you won’t lose much of that long-term growth.
The Bottom Line
To withdraw from your 401(k), speak to your human resources department first to explore your options. Withdrawing money early from your 401(k) can carry serious financial penalties, tax implications, and missed long-term growth.
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