401(k) withdrawal rules: Penalties, fees & how to do it

In a financial pinch, you may be tempted to turn to your retirement savings. But pulling from your 401(k) before you’re retired comes with risks and tax penalties that could take a chunk out of what you withdraw.

How to withdraw from your 401(k)

Accessing the funds of your 401(k) depends on your age and eligibility.

If you’re over 59 ½

Once you’re over the age of 59½, you’re free to withdraw funds from your 401(k) without penalty — although distributions are still subject to income tax. There are a few different ways to tap into your 401(k), and the best option depends on your life circumstances:

• Lump-sum withdrawal. If your company allows it, you can request a lump-sum distribution up to the total vested amount in your account. After receiving the funds, your 401(k) account is closed.
• Take qualified distributions. Request periodic distributions as an annuity, over a fixed period or for your lifetime.
• Let it sit. If you have more than $5,000 in your 401(k), opt to forgo distributions and let your savings continue to earn investment income up until the age of 72. At this time, you’ll need to start taking required minimum distributions.
• Roll it into an IRA. If you want to continue adding to your retirement savings after you retire, you’ll need to roll your 401(k) into an individual retirement account.

If you’re under 59 ½

Those who want to access their 401(k)’s early can, but withdrawal options are limited and often come with penalties. Here’s how to get the ball rolling:

1. Ask to make a withdrawal. Ask your employer if you can make an early withdrawal from your 401(k). Not all employers allow this, or only allow withdrawals under specific circumstances.
2. Find out how much you can withdraw. Some employers set restrictions on early withdrawals.
3. Get the paperwork. Ask your employer for the withdrawal application paperwork or download it from your 401(k) provider’s website.
4. Review the penalties. Make sure you understand the penalties and tax consequences associated with early withdrawals.
5. Complete your application. Fill out the early withdrawal form and submit it to your employer.

While you can withdraw from your 401(k) under the age of 59½, there are risks and penalties involved.

Risks and penalties of withdrawing early

There are three main disadvantages to making an early withdrawal from your 401(k):

• Early withdrawal penalty. Because these funds were held from your paycheck pretax, the IRS charges a 10% early withdrawal penalty.
• Applicable taxes. Taxes apply to 401(k) disbursements, so expect to forfeit 20% of your withdrawal for automatic tax withholding.
• Lost interest. Funds in a 401(k) grow out of compounding interest, so it may not be possible to recoup what you lose over time.

How can I avoid the 10% penalty?

Generally speaking, taxes and lost interest are unavoidable. But in some circumstances the IRS waives the 10% tax penalty:

• Substantially equal periodic payments (SEPP). The IRS may waive the 10% penalty if you agree to take at least one payment annually after you stop working for a minimum of five years, or until you reach the age of 59½ — whichever comes last.
• You leave your job. If you leave your job in the year you turn 55 or later and want to draw from your 401(k) ahead of schedule, the IRS may waive the early withdrawal penalty.
• You get divorced. If you need to cash out your 401(k) to divide it between you and your former spouse, you could have the penalty waived.

There are a few other life circumstances when the IRS could waive the 10% penalty on an early 401(k) withdrawal:

Hardship withdrawals

Another way to avoid the 10% early withdrawal penalty is if your withdrawal qualifies as a hardship withdrawal. An early withdrawal from your 401(k) can only qualify as a hardship withdrawal if it’s limited to the amount necessary to satisfy an immediate, heavy financial need.
Some of the circumstances that may qualify as a hardship withdrawal:

• Medical expenses
• Preventing foreclosure or eviction
• Funeral expenses

• Paying for post-secondary education
• Down payment on a home
• Repairs to your home

You’ll need to contact your 401(k) plan administrator to find out whether hardship withdrawals are permitted under your plan, and visit the IRS website to learn more about the requirements. Ask for a copy of your summary plan description agreement (SPD). This includes information about how and when you can make an early withdrawal from your account.

When is it a good idea?

Withdrawing funds from your 401(k) prior to retirement is a serious decision that you should only consider as a last resort. If you’re taking a hardship withdrawal, you could avoid the 10% penalty. But taking this penalty is not usually worth it.
For example, if you’d like to use a 401(k) disbursement to pay off debt, the withdrawal might be worthwhile if the interest rate on your debt is higher than the penalties you incur on the withdrawal.

Alternatives to withdrawing early

If you find yourself in a financial bind, consider a few of these alternatives to early 401(k) withdrawal:

• 401(k) loan. Borrow up to $50,000 or 50% from your retirement account — whichever is less — using a 401(k) loan. Interest on these loans is typically the Prime Rate plus 1% and you’ll be expected to repay the loan in five years. But it comes with its own risk: If you lose your job, you’ll have to pay back the entire amount within two to three months.
• Convert to an IRA. Individual retirement accounts have different withdrawal rules, so you could convert your 401(k) into an IRA to avoid the 10% penalty.
• Personal loan. If you’re seeking a loan with a longer repayment term, consider a personal loan. The loan amount and rate you qualify for hinges on your credit score, so compare your options with multiple lenders.
• Interest-free credit card. Some credit cards offer 0% introductory APRs that last between six and 21 months, depending on the card. Consider transferring existing debt to one of these cards if you think you can pay down the balance within the interest-free period.
• Home equity line of credit (HELOC). If you’ve built up equity in your home, you may be able to borrow against it using a HELOC.

How will withdrawing affect my taxes?

Retirement account distributions are considered taxable income, so you’re expected to pay taxes on any amount you withdraw. The IRS automatically withholds what you owe from the disbursement, but you may receive some of this back as a tax refund if your withholding exceeds your tax liability.

How quickly can I get the money?

How quickly you receive the funds from your 401(k) depends on your employer. Disbursements may be made by check or directly into your bank account, and could take up to several business days once the 401(k) withdrawal is approved.

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