What Are the Withdrawal Rules for a 401(k)?

Like most people, you probably have a 401(k) plan through your employer. This tax-advantaged retirement account is an excellent way to save for the future.

Ideally, you want to wait until age 59 ½ to start withdrawing from your 401(k). However, unplanned circumstances can create the need to withdraw funds early.  

Understanding the withdrawal rules for a 401(k) helps you make informed decisions about taking money early from your retirement account. The following information can help.

401(k) Withdrawal Rules

Distributions from a 401(k) account typically cannot be made until one of the following occurs:

• You pass away or become disabled

• The plan is terminated and not replaced with a new one

• You experience a financial hardship

If you are under age 59 ½, you likely cannot withdraw funds from a 401(k) plan. However, if the plan allows withdrawals or you meet the financial hardship requirements, you could be responsible for taxes and penalties.

In contrast, the IRS requires you to start taking withdrawals from a traditional 401(k) when you reach age 73. However, withdrawals from a Roth 401(k) are not required.

Costs of 401(k) Early Withdrawals

Withdrawals from a 401(k) account before age 59½ typically incur taxes and penalties:

• Federal income tax is taxed at your marginal tax rate.

• A 10% penalty is applied to the amount withdrawn.

• You pay relevant state income tax.

Considerations Before 401(k) Early Withdrawals

Along with taxes and penalties, consider the long-term opportunity cost of taking an early withdrawal from your 401(k):

• You typically have to pay back the loan immediately if you leave your employer.

• If you cannot repay your loan on time, the money will be considered a withdrawal, and you will be responsible for taxes and any penalties.

• Funds withdrawn early result in less money when you retire.

• Leaving a smaller amount of money in your retirement account reduces the impact of compound interest.

• You might need to work additional years to reach your retirement savings goal.

Penalty-Free Exceptions for 401(k) Early Withdrawals

Although income tax still applies, the 10% early-withdrawal penalty for a 401(k) account can be waived under specific circumstances:

• Birth or adoption: You can withdraw up to $5,000 per child for qualified birth or adoption expenses.

• Equal payments: You can take a series of substantially equal payments.

• Emergency personal expense: You may withdraw up to $1,000 each year for personal or family emergency expenses.

• Disaster recovery distribution: If you have economic loss due to a federally declared disaster, you can withdraw up to $22,000.

• Domestic abuse victim distribution: Victims of domestic abuse can withdraw $10,000 or 50% of their account, whichever is lower.

• Medical expenses: You can withdraw the amount of unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI).

• Military: If you’re a qualified military reservist who's been called to active duty, certain distributions can be made penalty-free.

• Separation from service: You leave your job during or after the year you turn 55; 50 for certain government employees.

• Death or disability: You won’t pay the 10% penalty if you’re totally and permanently disabled or you’re an account beneficiary and the account owner has passed away.

Alternatives to 401(k) Early Withdrawals

The following are alternatives to an early withdrawal from your 401(k):

401(k) Loan

 Find out whether your employer’s 401(k) plan permits loans:

• Even if loans are offered, employers are not required to provide them.

• Employers with plans that offer loans set the terms.

• Some employer plans require a minimum loan amount of $1,000.

• The maximum loan amount is $50,000 or half of your 401(k) plan’s vested account balance, whichever is less.

• The plan sets reasonable interest and repayment rates.

• The maximum repayment schedule is typically five years.

• The repayment schedule for a loan used as a down payment on a principal residence can be up to 30 years.

• Repayment amounts typically come out of your paycheck on an after-tax basis.

Hardship Withdrawal

Ask whether your employer’s 401(k) plan lets you withdraw money early if there is an immediate and heavy financial need and the withdrawal is limited to the amount necessary to satisfy this need:

• The plan administrator determines whether you have an immediate and heavy financial need.

• Large purchases and foreseeable or voluntary expenses typically don’t qualify.

• Withdrawals are subject to income taxes and a 10% early-withdrawal penalty, except under the circumstances listed in the section above.

Substantially Equal Periodic Payments

You typically can make substantially equal payments from your 401(k) account over your remaining life expectancy if your employment is terminated:

• After you establish substantially equal periodic payments, you cannot contribute to your 401(k).

• You cannot take distributions from your 401(k) beyond your substantially equal periodic payments.

• Since you must continue taking the substantially equal periodic payments each year to avoid the penalty tax, this strategy is best if you are retiring early and leaving the workforce.

The amount you can withdraw annually from your 401(k) is based on one of three methods:

1. Required minimum distribution: The minimum amount the U.S. government requires individuals to withdraw annually from certain retirement accounts once they reach a specific age. 

2. Fixed amortization method: The account balance is divided by your life expectancy according to IRS tables, and an IRS-approved interest rate is applied to arrive at a fixed annual withdrawal amount.

3. Fixed annuitization method: The annual payment is calculated by dividing your 401(k) account’s balance by an annuity factor derived from IRS tables and based on your life expectancy and a specified interest rate.

Individual Retirement Account Rollover Bridge Loan

You might be able to roll over your 401(k) balance into an individual retirement account (IRA):

• An indirect rollover means the money doesn’t need to be deposited into a new retirement account for 60 days.

• You can decide what to do with the money during this time.

• If the money isn’t deposited into an IRA within the 60 days, the IRS will consider this an early distribution, and the funds will be subject to taxes and penalties.

• If you don’t roll over the balance to an IRA, the 401(k) plan is required to withhold 20% of the amount for federal taxes.

• You must make up the 20% from other sources for the 60-day rollover to avoid taxation.

• An IRA bridge loan is a risky move that most financial professionals do not advise.

Roth Individual Retirement Account Conversion

A Roth IRA conversion doesn’t allow access to your money penalty-free right away. However, this method makes some of your money more accessible in the future:

• You can convert the money in a 401(k) to a Roth IRA.

• Any pre-tax money you convert is taxable.

• After five years, you can access the converted funds at any time for any purpose.

Consider talking with a licensed financial professional to explore your options and make informed decisions about your investments.

*This information is for educational purposes only.