What to Know About 401(k) Withdrawals

There are rules for taking money out of your 401(k) for retirement, and possible penalties if you do it before.

Written by Anisa Purbasari Horton / March 4, 2022

Quick Bites

  • You can start making withdrawals from your 401(k) when you turn 59½.
  • There are typically penalties associated with early withdrawals from your 401(k), except in special cases.
  • In place of withdrawals, a loan might be a better option for you if your plan allows for it.
  • If you have a Roth IRA, it’s better to tap into that as there are more options for withdrawing without penalties.
  • Taking money out early from your retirement savings should be a last resort.

A 401(k) is a retirement and savings plan. You’re supposed to contribute money to it regularly until you get to retirement age. Then you can draw from it as needed, reaping the benefits of your hard-earned savings and the prudent money habits you’ve stuck to over the years. In a perfect world, you’d leave your money untouched until then.

Unfortunately, no one lives in a perfect world and financial emergencies are all too common. And when retirement seems like a far-away concept, it can be tempting to take just a little bit of money from your 401(k), especially if you’ve been contributing for a while and have got a solid amount tucked away. After all, a little bit won’t make a difference, right?

Well, yes and no. It’s technically possible, but there are potential consequences that you should definitely be aware of.

Inside this article

  1. 401(k) withdrawal basics
  2. Early withdrawal consequences
  3. Possible early withdrawals
  4. Avoiding the 10% penalty
  5. Taking a loan from your 401(k)
  6. Tapping your Roth IRA
  7. Use it as a last resort

The basics of 401(K) withdrawals

You can typically start making withdrawals when you turn 59½, but you are not required to do so until you turn 72. The age limit was 70½, but changes to the Setting Every Community Up for Retirement Enhancement (SECURE) Act changed the age limit.[1] You don’t have to be retired to start taking money out of your 401(k), but if you’re still working at a company that administers your 401(k) plan, the rules will depend on the terms of your plan as well as whether you own (and how much) stock in that company.[2]

Withdrawals can either come in the form of lump sum or periodic payments. Some plans allow you to make a choice between the two. A lump sum option might make sense if you need a big amount of cash at the time you start your withdrawal, but the disadvantage is that you’ll have to pay income taxes on that amount. If you opt for periodic distributions, however, you’ll only have to pay taxes on the distributions that you take that year, and you can continue to reap the benefits of compound interest on the rest of your tax-deferred dollars until the time you withdraw that money.[3]

What about Social Security benefits? Well, given that they are treated as two separate plans, what you do with one doesn’t impact the other. You can theoretically take 401(k) withdrawals while also receiving Social Security benefits, or you can delay one while receiving the other (you can start collecting Social Security benefits between the ages of 62 and 70).[4]

Tip: Financial experts often recommend tapping into other taxable accounts first before withdrawing from your 401(k), because the longer you leave your tax-deferred dollars in your 401(k), the more potential it has to grow.[5]

Consequences of early withdrawals

Now that you know how withdrawals work, what about if you want to take money out before you turn 59½? Generally, funds from your 401(k) cannot be distributed until you reach 59½ years of age, with certain exceptions (more on that later). This is the case whether you get your money as a lump sum or in periodic installments.[6]

If you want to make a withdrawal before you reach the age of 59½, you will likely face financial penalties unless you meet one of the exceptions that the IRS has listed.

  • First, you’ll have to pay a 10% penalty on the amount you withdraw.

  • On top of that, you’ll probably have to fork out some amount for federal, state and local taxes because 401(k) withdrawals are treated as income.[7]

Whether or not you can make early withdrawals also depends on the terms of your plans. Paco de Leon, founder of The Hell Yeah Group, a financial firm that works primarily with creatives and author of Finance for the People: Getting a Grip on Your Finances, suggests that the first thing someone should do when considering making an early withdrawal is speak to their plan administrator.

“All 401(k) plans have an advisor who is in charge of managing the fund, guiding the participants and giving them advice. I suggest taking the time to speak to the advisor so you can fully understand your options and consequences,” she says.

That being said, the IRS has released a guideline that details the possible consequences of early withdrawals, although the extent to which these apply will differ from plan to plan. Let’s look at potential circumstances where you might be eligible for an early withdrawal, and what that means for your 401(k).

When can you make early withdrawals?

The IRS guideline states that early withdrawals are possible in the following circumstances, though you may have to pay income taxes on the amount and may incur a 10% tax penalty (more on this below):

  • You’re fired from your job

  • Your plan is terminated and your employer hasn’t made arrangements for a successor to take over

  • You become permanently disabled or die

  • You have an “immediate and heavy financial need” (also often referred to as “hardship withdrawals”)

According to the IRS, an “immediate and heavy financial need” covers the following circumstances:

  • Medical expenses—whether incurred by yourself, or your spouse or dependent

  • Costs relating to the purchase of your primary residence for first-time homebuyers (excluding mortgage payments)

  • Expenses for post-secondary education

  • Any fees you need to pay to avoid getting evicted for having your home foreclosed

  • Funeral expenses

  • Costs related to repairing damage to your primary residence

Ultimately, whether or not your circumstances qualify as a hardship withdrawal depends on the terms of your plan and your plan administrator. Keep in mind that the amount you can withdraw is “limited to the amount necessary to satisfy that financial need,” according to the IRS. And unless you qualify for the exceptions listed below, you’ll still have to pay the 10% penalty and additional income taxes.[8]

Avoiding the 10% penalty

So are there any circumstances where you don’t have to pay the 10% penalty if you withdraw before turning 59½? Yes, if the reason for withdrawal is death or disability.

The IRS also has a bunch of other exceptions where you might be able to avoid the 10% penalty (though you’ll still have to pay income taxes). Again, this is dependent on your plan, but it generally covers the following circumstances:

  • You have medical expenses that exceed 10% of your annual gross income

  • You have to make court-ordered payments to your former partner or dependent in the aftermath of a divorce

  • You’re a military reservist and are called to active duty

Taking a loan from your 401(k)

In lieu of withdrawals, an option to consider is taking out a loan from your 401(k).[7] You’re essentially borrowing money from your retirement savings account. While you do technically have to pay principal and interest, you’ll be doing so to your own account rather than to a third party.

The maximum you can borrow is the lesser amount of 50% of your vested balance or $50,000. You typically have to pay back the loan within five years unless you’re using that loan toward buying a home that serves as your primary residence. The specific interest rate and repayment period will depend on the terms of your plan.[9]

Consider withdrawing from a Roth IRA instead

With a Roth IRA, if you meet the criteria for a “hardship withdrawal,” which are the same as for your 401(k), you’re exempt from paying the 10% penalty.

Say that your spouse is in school and you don’t quite have enough to pay for their tuition costs for the upcoming semester. If you withdraw from a 401(k), you’ll have to pay a 10% penalty in addition to income taxes. But if you withdraw from a Roth IRA, you won’t be subject to the 10% penalty (though you still have to pay income tax).

Tip: You might be thinking, what if I convert my 401(k) into a Roth IRA to take advantage of possible early withdrawals without the 10% penalty? While it’s possible, there may be taxes associated with that rollover if you don’t structure it correctly.[10] So before you do this, it’s best to speak to a professional.

Make early withdrawals a last resort

Tapping into your retirement reserves comes with significant financial consequences—which can be hard to wrap your head around when your retirement seems so far away. “Since ultimately the funds are not being used for what they were intended to be used for, it’s not advised to take an early withdrawal,” says de Leon.

“The worst-case scenario is when someone makes an early withdrawal from their retirement and they are either forced into delaying their retirement or facing the reality that they don’t have enough to retire with the lifestyle they had in mind.”

That said, de Leon does acknowledge that there are times when it might be a good idea. For example, withdrawing money for the down payment of a home can potentially pay off in the long run, because it is an investment rather than a depreciating asset.[11]

But what about if you’re stuck with an unexpected emergency, and your 401(k) is the only asset left to tap? In that case, de Leon suggests ensuring that you start implementing habits that will prevent you from potentially dipping into your retirement savings at another future date.

“If you’re going to take an early withdrawal, a best-practice going forward is to max out your 401(k) every year that you’re working,” says de Leon. If you can’t do this now, figure out the intermediate steps that will get you there. Can you save bonuses, tax returns and windfalls, and cut expenses, divert savings and strategize a way to increase your income so you can contribute more to your 401(k)?

De Leon suggests saving emergency fund money in a high-yeld, money market account, and to ensure that you get into the habit of building a financial reserve outside of retirement accounts in addition to contributing to your 401(k).

It’s “best practice to keep your funds with different goals separated,” says de Leon. And your 401(k) should be left alone for the very purpose that it is designed for—which is to take care of yourself during your retirement years.

Article Sources
  1. “Secure Act Alters 401(k) Compliance Landscape,” SHRM, https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/secure-act-alters-401k-compliance-landscape.aspx.
  2. “What are Retirement Withdrawal Strategies?” Blackrock, https://www.blackrock.com/us/individual/education/retirement/withdrawal-rules-and-strategies.
  3. “Pension Lump-Sum Payouts and Your Retirement Security,” CFPB, https://files.consumerfinance.gov/f/201601_cfpb_pension-lump-sum-payouts-and-your-retirement-security.pdf;https://www.finra.org/investors/learn-to-invest/types-investments/retirement/managing-retirement-income/selecting-retirement-payout-methods.
  4. “Social Security vs. 401(k),” Findlaw, https://www.findlaw.com/socialsecurity/retirement-planning/social-security-vs-401k.html#:~:text=When%20you%20retire%2C%20you%20can,is%20considered%20non%2Dwage%20income.&text=That's%20%24570%20more%20than%20earned%20in%20early%20retirement; https://www.ssa.gov/benefits/retirement/planner/agereduction.html#:~:text=You%20can%20start%20receiving%20your,your%20benefit%20amount%20will%20increase.
  5. “Do you have a Retirement Spending Plan?” Merrill Lynch, https://www.ml.com/articles/the-basics-q-a-income-that-measures-up.html.
  6. “401(k) Resource Guide—Plan Sponsors,” IRS, https://www.irs.gov/retirement-plans/plan-sponsor/401k-resource-guide-plan-sponsors-general-distribution-rules#tax-on-early-distributions.
  7. “401(k) Resource Guide—Plan Participants,” IRS, https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules.
  8. “Retirement Topics—Hardship Distributions,” IRS, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions.
  9. “Retirement Topics—Plan Loans,” IRS, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-loans.
  10. “Retirement Topics—Exceptions to Tax on Early Distributions,” IRS, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions.
  11. “401(k) Loans, Hardship Withdrawals and Other Important Considerations,” FINRA, https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-loans-hardship-withdrawals-and-other-important-considerations.

About the Author

Anisa Purbasari Horton

Anisa Purbasari Horton

Anisa writes and edits stories about all things related to the intersection of work and life—whether that’s productivity, personal finance, careers, leadership, psychology, or workplace culture. In addition to Sound Dollar, she also writes fo Business Insider, BBC Work Life and more.

Full bio

Related Content