Can Money Be Taken Out Of 401k? Yes, money can be taken out of a 401k, but early withdrawals often come with significant financial implications. At money-central.com, we guide you through the complexities of 401k withdrawals, helping you understand when and how you can access your retirement funds while minimizing penalties and taxes. Explore our resources for informed financial decisions, retirement planning strategies and investment management insights.
1. What Are The General 401k Withdrawal Rules?
Generally speaking, you can’t access funds from a workplace retirement plan until certain conditions are met. The IRS outlines specific instances that allow for distributions from a 401(k) plan. According to the IRS, distributions from a workplace retirement plan cannot be made until one of the following happens:
- You die or become disabled.
- The plan is terminated and isn’t replaced by a new one.
- You reach age 59 ½.
- You experience a financial hardship.
Account holders under age 59 ½ often can’t take 401(k) withdrawals from a current employer’s plan at all. If a plan does allow withdrawals or financial hardship requirements are met, you may still be responsible for taxes and penalties.
On the other end of the spectrum, the IRS requires that you begin taking 401(k) withdrawals once you reach age 73. This requirement only applies to pre-tax 401(k) accounts, not Roth accounts.
2. What Are The Costs of Early 401k Withdrawals?
Early withdrawals from a 401(k) account can be expensive due to taxes and penalties. If you take a distribution from a 401(k) before age 59½, you will likely owe:
- Federal income tax (taxed at your marginal tax rate).
- A 10% penalty on the amount that you withdraw.
- Relevant state income tax.
It’s a good idea to avoid tapping any retirement money until you’ve at least reached age 59½. Workers have flexibility to change jobs without losing retirement savings. But that can fall apart if retirement savings plans are used like bank accounts in the years preceding retirement. In general, it’s a good idea to avoid tapping any retirement money until you’ve at least reached age 59½.
3. How Does Taxation Impact Early 401k Withdrawals?
The IRS imposes a 10% additional tax on early 401(k) withdrawals, on top of the ordinary income taxes you’ll be subject to. The IRS imposes a 10% additional tax on early 401(k) withdrawals, on top of the ordinary income taxes you’ll be subject to. Suppose you decide to withdraw $25,000 from your 401(k) plan. First, your withdrawal will be subject to income taxes — this is the case no matter when you make your withdrawal, unless it’s a Roth account.
A single person with an income of $75,000 will have a marginal tax rate of 22%, meaning that’s the rate at which the highest portion of income is taxed. As a result, you’ll pay $5,500 in federal income taxes on the withdrawal. Thanks to the 10% early withdrawal penalty, you’ll owe an additional $2,500. That’s a total of $8,000 in taxes on a $25,000 withdrawal.
You may also be subject to state income tax on your 401(k) withdrawal, depending on where you live. Whether a tax applies and how much you’ll pay varies by state.
4. What Should You Consider Before Withdrawing From Your Retirement Account?
Consider the long-term opportunity cost of taking early withdrawals from your account. Retirement may feel like an intangible future event, but hopefully, it will be your reality someday. Funds withdrawn early from a 401(k) will result in less money in the account by the time you retire.
Let’s look at the long-term impact of a $25,000 early 401(k) withdrawal. Suppose you’re 40 at the time of the withdrawal, and you plan to retire at 65. That’s 25 years that $25,000 would have to potentially grow and compound. Assuming your account grows at a rate of 7%, that $25,000 would become $135,686 by the time you reach 65. While $25,000 may seem like a relatively minor amount of money, you’re robbing your future self of potentially far more.
Another thing to consider is investing a portion of your retirement savings into a Roth IRA. While you’ll still have the long-term opportunity cost of early Roth IRA withdrawals, you won’t be subject to the income and early withdrawal taxes you would on a 401(k).
5. Are There Penalty-Free Exceptions For Early 401k or IRA Withdrawals?
Yes, the Internal Revenue Code (IRC) provides exceptions to the 10% penalty rule. Before you pay the penalty, be aware that there are several circumstances where the Internal Revenue Code (IRC) provides exceptions to the 10% penalty rule. These exceptions may make it possible to tap retirement savings in a time of need without paying the extra penalty.
Even if the 10% penalty is avoided, you will still owe income tax on any premature IRA or 401(k) distributions.
Also, remember these are broad outlines. Anyone wanting to tap retirement funds early should talk to their financial professional.
Here are the exceptions to the IRS 10% penalty tax on early 401(k) withdrawals:
- Birth or adoption: You can withdraw up to $5,000 per child for qualified birth or adoption expenses.
- 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.
- 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.
- Emergency personal expense: Each person may withdraw up to $1,000 each year for personal or family emergency expenses.
- Equal payments: You can take penalty-free withdrawals if you take a series of substantially equal payments, which we’ll discuss more later.
- 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 won’t pay the penalty on withdrawals if you leave your job during or after the year you turn 55 (50 for certain government employees).
6. What Options Should You Consider Before An Early Withdrawal?
If you’re facing financial hardship or need money from your 401(k) for some other reason, there are several options you can consider.
6.1. 401(k) Loan
The IRC allows you to borrow from your 401(k), provided your employer’s plan permits it. The IRC allows you to borrow from your 401(k), provided your employer’s plan permits it. It’s important to note that not all employer plans allow loans, and they aren’t required to do so. If your plan does allow loans, your employer can set the terms.
The maximum loan permitted under the IRC is $50,000 or half of your 401(k) plan’s vested account balance, whichever is less.
Principal and interest is paid at a reasonable rate set by the plan. These payments typically come out of your paycheck on an after-tax basis. Generally, the maximum term length is five years. However, if you use the loan as a down payment on a principal residence, it can be as long as 30 years. Some employer plans require a minimum loan amount of $1,000.
401(k) loans have several benefits, including:
- No credit checks.
- The loan doesn’t appear on a credit report.
- Interest is paid to your plan account instead of a third-party lender.
Of course, the loans also have some downsides. Taking a 401(k) loan depletes your principal balance, at least temporarily. It will cost you any compounding that your borrowed funds would have received.
Additionally, if you leave your employer for any reason, whether it’s your own choice or not, you’ll usually have to pay back the loan immediately. If you can’t repay your loan, whether it’s within the five-year term or if you leave your job, it will be considered a withdrawal, and you’ll be responsible for taxes and any applicable penalties.
6.2. Hardship Withdrawal
Some 401(k) plans allow what is called a hardship withdrawal, which allows someone to withdraw from your 401(k) plan if the following are true:
- There is an immediate and heavy financial need.
- The withdrawal is limited to the amount necessary to satisfy the financial need.
The IRC authorizes the withdrawals, but it’s up to each individual plan to decide whether to allow them. It’s up to the plan administrator to determine whether the employee has an immediate and heavy financial need. Large purchases and foreseeable or voluntary expenses generally don’t qualify.
For example, a hardship withdrawal might be a good fit if you need money to pay your child’s college tuition. However, it wouldn’t be available if you wanted to upgrade your car or take your family on vacation.
It’s important to note that while a hardship withdrawal allows you to withdraw from your current 401(k) plan, it doesn’t exempt you from income taxes or the 10% additional penalty, except in those situations listed in the section above.
6.3. Substantially Equal Periodic Payments (SEPP)
The IRC allows those under the age of 59 ½ to withdraw from their 401(k) plans without the 10% additional penalty if they do so in the form of a series of substantially equal payments over their remaining life expectancy.
In order to establish a SoSEPP, you typically need to be terminated from your employer. Once established, you can’t continue to contribute to the account, nor can you take any distributions other than your SoSEPP payments. The amount you can withdraw each year is based on one of three methods: the RMD method, a fixed amortization method, or a fixed annuitization method.
Because you must continue taking the SoSEPP distributions each year to avoid the penalty tax, this strategy is best for individuals who are retiring early and leaving the workforce.
6.4. IRA Rollover Bridge Loan
There is another way to “borrow” from a 401(k) on a short-term basis if you are eligible to take a distribution, but it’s less official than a 401(k) loan. You can roll your 401(k) balance over into an individual retirement account (IRA). When you roll an account over, the money doesn’t have to be deposited into the new retirement account for 60 days (called an indirect rollover). During that period, you could theoretically do whatever you want with the money.
However, if the money isn’t safely deposited into an IRA when the 60 days are up, the IRS will consider this an early distribution, and you’ll be subject to taxes and penalties. Also, if you do not rollover your balance directly to an IRA, the plan is required to withhold 20% from the amount for federal taxes. You will need to make up that amount from other sources for the 60-day rollover to avoid taxation.
This is a risky move that is generally frowned upon by financial professionals. However, if you want an interest-free bridge loan and you’re sure you can pay it back, it’s an option.
6.5. Roth IRA Conversion
Unlike the other strategies on our list, a Roth IRA conversion won’t allow you to access your money penalty-free right away. However, it’s a way to make some of your money more accessible in the future.
The IRS allows you to convert the money in a traditional IRA or 401(k) to a Roth IRA. You’ll have to pay the income taxes on any pre-tax money you convert, and then you’ll be subject to a five-year waiting period. However, once the five years pass, you can access the converted funds at any time for any purpose.
6.6. Consider Alternatives
It can be tempting to withdraw money from your retirement account when you’re facing a financial rough patch, but this strategy should generally be considered as a last resort. In addition to the taxes and penalties you’ll pay, you’re also robbing your future self of money for retirement.
Depending on your situation, there may be other options available, including using your emergency fund, getting a personal loan, or taking equity from your home using a home equity loan, home equity line of credit (HELOC), or a cash-out refinance.
Consider speaking with a financial professional to explore all options available and make an informed decision based on your individual circumstances.
7. What Are The Pros and Cons of 401k Withdrawal vs. 401k Loan?
Understanding the advantages and disadvantages of each option can guide you in making the most suitable choice for your situation.
7.1. 401(k) Withdrawal
| Pros | Cons |
|---|---|
| You’re not required to pay back withdrawals. | Early withdrawal penalties and taxes apply if under 59½ years old. |
| Potential penalty-free withdrawals in certain situations. | Loss of potential growth due to lower account balance. |
| Immediate access to funds for emergencies or financial needs. | Withdrawn money is not replenished, unlike with a 401(k) loan. |
| Potential withdrawal restrictions and eligibility criteria. |
7.2. 401(k) Loan
| Pros | Cons |
|---|---|
| No taxes or penalties are incurred on the borrowed amount. | Risk of default if unable to repay, leading to taxes and penalties. |
| Interest payments contribute back into the retirement account. | Requirement to repay loan in full upon leaving current job. |
| No impact on credit score if payment missed or defaulted. | Limits potential investment growth due to borrowed funds being outside the retirement account. |
| Potential restrictions on loan eligibility and terms based on plan provisions. |
8. Understanding the Impact of Early Withdrawals on Retirement Savings
Withdrawing money from a 401(k) before age 59 ½ usually results in taxes and costly penalties, but there are several ways to withdraw money penalty-free. Understanding the long-term effects of early withdrawals is essential for securing your financial future. Still, it may be best to not touch retirement savings until retirement.
Compounding can have a significant impact on maximizing retirement savings and extend the life of a portfolio. You lose out on that when you take early distributions.
It’s always possible for unforeseen circumstances to arise before retirement. Being aware of the penalty exceptions allows for informed decisions, and to possibly avoid paying extras and fees. However, it’s also important to explore other options.
9. Seeking Professional Financial Advice
Navigating the complexities of 401(k) withdrawals can be daunting. If you’re considering an early 401(k) withdrawal, use the Empower 401(k) Early Withdrawal Calculator to run the numbers and learn how much you’ll owe in taxes and fees, as well as the projected account loss as a result of the withdrawal. Consulting with a financial advisor ensures you make informed decisions aligned with your financial goals.
10. Frequently Asked Questions (FAQ) About 401(k) Withdrawals
| Questions | Answers |
|---|---|
| Can I withdraw money from my 401(k) before age 59 ½? | Yes, but it usually results in taxes and penalties unless you meet specific exceptions. |
| What is the penalty for early 401(k) withdrawal? | Generally, a 10% federal tax penalty applies, in addition to ordinary income taxes. |
| Are there any exceptions to the early withdrawal penalty? | Yes, exceptions include birth or adoption expenses, death or disability, disaster recovery, and certain medical expenses. |
| What is a hardship withdrawal? | A withdrawal allowed by some 401(k) plans for immediate and heavy financial needs, subject to plan administrator approval and potential taxes and penalties. |
| What is a 401(k) loan? | An option to borrow money from your 401(k) account, with interest paid back into the account, but it must be repaid according to the plan terms to avoid taxes and penalties. |
| How does a Roth IRA conversion affect my 401(k)? | Converting a traditional 401(k) to a Roth IRA involves paying income taxes on the converted amount, but future withdrawals may be tax-free. |
| What are Substantially Equal Periodic Payments (SEPP)? | A method allowing penalty-free withdrawals before age 59 ½ by taking a series of substantially equal payments over your remaining life expectancy. |
| What are the tax implications of early 401(k) withdrawals? | Early withdrawals are subject to ordinary income taxes and a 10% federal tax penalty, unless an exception applies. |
| How do early withdrawals affect my retirement savings? | Early withdrawals reduce your retirement savings and potential investment growth, impacting your long-term financial security. |
| Where can I find more information and tools to help me decide about early 401(k) withdrawals? | Visit money-central.com for comprehensive articles, calculators, and resources to help you make informed decisions about managing your 401(k) and retirement savings. |
Understanding the rules and implications of 401(k) withdrawals is essential for making informed financial decisions. At money-central.com, we are committed to providing you with the resources and guidance you need to navigate the complexities of retirement planning. Whether you’re considering an early withdrawal, exploring alternative options, or seeking professional advice, our goal is to empower you to achieve financial security and peace of mind.
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