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Part of the Series Strategies to Maximize Your 401(k)Fees and Returns
Retirement and 401(k)s
Other Types of 401(k)s and Retirement Plans
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Investors in a 401(k) plan must wait until retirement before taking distributions or withdrawals from the account. Taking funds out before 59½ incurs a 10% early withdrawal penalty plus income taxes due on the distribution from the Internal Revenue Service (IRS).
However, life events can happen, and you may need to tap into your retirement funds early. There are a few ways to withdraw from a 401(k) early without a penalty.
IRS rules dictate that investors can withdraw funds from their 401(k) account without penalty only after they reach age 59½, become permanently disabled, or are otherwise unable to work.
Distributions from a traditional 401(k), where the tax was deferred while saving, means investors pay income tax at their current ordinary tax rate. Those with a Roth 401(k) account have already paid tax on the money saved, so withdrawals are tax-free. That also includes any earnings on the Roth account.
Plan participants must take required minimum distributions (RMDs) from their 401(k) each year when they reach age 72 or 73 if they reach age 72 after Dec. 31, 2022.
IRS rules dictate that investors can withdraw funds from their 401(k) account without penalty only after they reach age 59½, become permanently disabled, or are otherwise unable to work.
You may be eligible to take early distributions from your 401(k) without penalty if you meet certain criteria with a hardship distribution. It requires an immediate and heavy financial burden you couldn't afford to pay. Hardship distributions are only allowed up to the amount needed to relieve the hardship.
Withdrawals exceeding that amount are considered early distributions and are subject to the 10% penalty tax. The plan administrator must approve any hardship distribution, and individuals will still owe income tax on their distribution. Qualifying expenses may include:
Home-buying expense withdrawals are commonly used for a down payment to secure a mortgage or closing costs.
Those who do not meet the criteria for a hardship distribution may be able to borrow from their 401(k) before retirement. The specific terms of these loans vary among plans and administrators. Loans from a 401(k) include interest, which is deposited back into the 401(k) and treated as investment income.
All loans must be repaid within five years unless it is used to finance the purchase of a primary residence. For employees in the armed forces, the loan term is extended by the length of their active service, without penalty. Individuals who lose or resign from their jobs must repay the loan by the due date of their federal income tax return, including extensions.
The IRS provides some basic guidelines for loans that won't trigger the additional 10% tax on early distributions. For example, a loan from a traditional or Roth 401(k) cannot exceed the lesser of 50% of the vested account balance or $50,000. Although borrowers may take multiple loans at different times, the $50,000 limit applies to the combined total of all outstanding loan balances.
A hardship withdrawal or a loan from a 401(k) is not determined by the IRS but by the employer, the plan sponsor, and the plan administrator.
Substantially Equal Periodic Payment (SEPP) distributes funds from an individual retirement account (IRA) or other qualified retirement plans before 59½ and avoids incurring IRS penalties. IRA owners can take an early distribution without penalty as part of IRS rule 72(t). SEPP withdrawals are not permitted from the qualified retirement plan while still employed with the plan sponsor.
The money can come from an IRA via SEPP at any time. The distributions are formulated as a series of equal periodic payments over an individual's life expectancy using the IRS tables. Once SEPP payments begin, they must continue for five years or until age 59½, whichever comes later. Those who fail to meet the program's requirements incur the 10% early tax penalty.
SEPP can help those close to retirement who want to begin distributions before 59½ but may deplete retirement savings too soon.
If you lose your job or retire when you're age 55 but not yet 59½, you might be able to take distributions from your 401(k) without the 10% early withdrawal penalty. The IRS allows an employee—who has been separated from their employer—to receive a penalty-free distribution from the qualified plan in the year of turning 55 or older.
However, this only applies to the 401(k) from the employer you just left, not any earlier employer plans or individual retirement accounts (IRAs). If you transferred or rolled over IRA funds from a previous employer into a current 401(k) before you retire at age 55, those funds would qualify for penalty-free distributions.
Taking an early 401(k) withdrawal doesn't have to permanently derail retirement plans. Future retirees can catch up on retirement savings in several ways:
Consider consulting with a fiduciary while making your retirement plan, especially if you're catching up on savings.
Early withdrawals from a 401(k) incur a 10% penalty. This penalty is in addition to income tax based on your ordinary tax rate.
If you resign from a position or are laid off or fired, you may retain control over your 401(k) account. You can close the existing account, roll funds into a different retirement account, or withdraw the money. If the 401(k) is not rolled over correctly and you are not eligible to make distributions, the money will be subject to taxes and a 10% penalty.
Individual contributions into a 401(k) belong to the employee. Vesting requires employees to fulfill a specified term of employment to gain access to benefits, such as retirement funds. When the employee leaves a company, the employee often retains ownership of those funds and can roll those into a different retirement account. If you leave a company before partial or full vesting, you will lose a portion or all of the your contributions.
A 401(k) is designed to provide retirement income. In most circumstances, withdrawing money before age 59½ means paying a 10% early withdrawal penalty (plus income taxes). However, those who need money for a major expense, such as important medical treatment, a college education, or buying a home, may qualify for a hardship distribution or 401(k) loan.
