For many people nearing retirement age, their 401(k) account is their biggest asset, as it took years of contribution to build.
However, some might need to consider dipping into these funds before retirement age if facing an unexpected financial expense, hardship or want to make a big purchase. While it is possible to withdraw money from your 401(k) before retirement, it can be very costly depending on the situation. Make sure you know the facts so that you can make an educated decision.
RULES FOR 401(K) WITHDRAWALS
Typically, you must wait until age 59.5 before making withdrawals without a penalty. However, most employers have additional rules for their 401(k) plans that allow withdrawals of contributed amounts, but not the earnings from those contributions.
To make withdrawals without penalty, you must be in a hardship situation with an immediate financial need, which might include:
- Unreimbursed medical expenses for you, your spouse, or your dependents
- Purchasing or repairing damage to your personal residence
- Payments to avoid eviction from a primary residence or foreclosure on a primary residence
- Paying college expenses or room and board for you, your spouse, or your dependents
- Funeral expenses
- Other types of immediate and substantial financial needs
These early withdrawals can significantly affect your balance at retirement. Withdrawn amounts will not generate any additional earnings between the time of withdrawal and your retirement.
PENALTIES AND EXCEPTIONS
In general, you must pay a 10% penalty on the amount of your withdrawal if you are not at least 59.5 years old. You'll pay this when you file your taxes and will be responsible for any income taxes you owe on the withdrawal amount. If you have a Roth 401(k) account, you will not owe income taxes on the withdrawal, but you may still owe the 10% penalty.
However, there are some cases where you can make early withdrawals without a 10% penalty, but you’ll still have to pay any income tax due on the withdrawal. These special exceptions include:
- Medical costs that exceed 10% of your adjusted gross income for the year
- Total and permanent disability
- A court order to give money to your child, other dependent, or ex-spouse
- Leaving the workforce when at least 55 years of age
- Setting up "substantially equal" withdrawals (usually based on life expectancy) that must continue for at least five years or until you are age 59-1/2. This is based on IRS rule 72(t)
- You are a military reservist being called to active duty
BORROWING INSTEAD OF WITHDRAWING
Another option is to borrow from your 401(k). Many employers allow you to borrow up to the lesser of $50,000 or half of your account balance. You pay interest on the loan, but that interest goes back into your 401(k) account.
Keep in mind that if you leave your job, voluntarily or not, the loan will become due immediately. If you do not pay it back, you will face the early withdrawal penalties.
WEIGH ALL FACTORS
It’s important to take all of this information into consideration when deciding to withdraw or borrow money from your 401(k).
Revised 2022