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You can make an early 401(k) withdrawal at any age, but doing so could trigger a 10% early distribution tax, on top of ordinary income taxes.
Some reasons for taking an early 401(k) distribution are penalty-free, such as a hardship withdrawal or if you leave your job.
Converting a 401(k) to an IRA could also be a way to keep your funds and avoid the early distribution penalty.
Cashing out your 401(k) might seem appealing if you’re short on money or nervous about the market, but the consequences may be more than you expect.
To make penalty-free withdrawals from retirement accounts, account holders must first reach 59 ½. There may be exceptions, depending on the type of 401(k) or retirement plan that you have.
If you choose to cash out your 401(k) early, it may lock in your losses, especially if the market is down when you make the withdrawal, says Adam Harding, a certified financial planner in Tempe, Arizona. That may mean less money for your future.
“If you're pulling funds out, it can severely impact your ability to participate in a rebound, and then your entire retirement plan is offset,” says Harding.
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What is the 401(k) early withdrawal penalty?
If you withdraw money from your 401(k) before you’re 59 ½, the IRS usually assesses a 10% tax as an early distribution penalty. That could mean giving the government $1,000, or 10% of a $10,000 withdrawal, in addition to paying ordinary income tax on that money. Between the taxes and penalty, your immediate take-home total could be $7,000 from your original $10,000.
What reasons can you withdraw from your 401(k) early?
In certain situations, you may be able to withdraw from your 401(k) without incurring the 10% early distribution tax penalty.
If any of these situations apply to you
Generally, the IRS will waive the early distribution tax penalty if these scenarios apply:
You choose to receive “substantially equal periodic” payments. Basically, you agree to take a series of equal payments (at least one per year) from your account. They begin after you stop working, continue for life (yours or yours and your beneficiary’s) and generally have to stay the same for at least five years or until you hit 59 ½ (whichever comes last). A lot of rules apply to this option, so be sure to check with a qualified financial advisor first.
You leave your job. This works only if it happens in the year you turn 55 or later (50 if you work in federal law enforcement, federal firefighting, customs, border protection or air traffic control).
You have to divvy up a 401(k) in a divorce. If the court’s qualified domestic relations order in your divorce requires cashing out a 401(k) to split with your ex, the withdrawal to do that might be penalty-free.
You become or are disabled.
You rolled the account over to another retirement plan (within 60 days).
Payments were made to your beneficiary or estate after you died.
You gave birth to a child or adopted a child during the year (up to $5,000 per account).
The money paid an IRS levy.
You were a victim of a disaster for which the IRS granted relief.
You over-contributed or were auto-enrolled in a 401(k) and want out (within certain time limits).
You were a military reservist called to active duty.
Finally, a provision in the Secure 2.0 Act, which became law at the end of 2022 and revised many of the government's rules for retirement plans, will allow special emergency distributions of up to $1,000 per year beginning in 2024.
If you qualify for a hardship withdrawal
A hardship withdrawal is a withdrawal of funds from a retirement plan due to “an immediate and heavy financial need.” A hardship withdrawal is limited to the amount needed to meet that need, and usually isn't subject to penalty .
The Secure 2.0 Act also has a new provision for hardship withdrawals in specific emergency expenses.
Generally, these things qualify for a hardship withdrawal:
Medical bills for you, your spouse or dependents.
College tuition, fees, and room and board for you, your spouse or your dependents.
Money to avoid foreclosure or eviction.
Certain costs to repair damage to your home.
How to make a hardship withdrawal
Your employer’s plan administrator usually decides if you qualify for a hardship withdrawal. You may need to explain why you can’t get the money elsewhere. You usually can withdraw your 401(k) contributions and maybe any matching contributions your employer has made, but not normally the gains on the contributions (check your plan). You may have to pay income taxes on a hardship distribution, and you may be subject to the 10% penalty mentioned earlier.
Under the new Secure 2.0 Act, Section 115 allows for one emergency distribution per year from a tax-preferred retirement account (excluding exceptions). For distributions made after December 31, 2023, you can withdraw up to $1,000, with the ability to repay the amount within three years. Within those three years, no other emergency distributions can be taken out of the account unless the amount has been repaid.
If you are converting your 401(k) to an IRA
Individual retirement accounts — known as IRAs — have slightly different withdrawal rules from 401(k)s. You might be able to avoid that 10% 401(k) early withdrawal penalty by converting an old 401(k) to an IRA first. For example:
There’s no mandatory withholding on IRA withdrawals. That means you might be able to choose to have no income tax withheld and thus get a bigger check now. (You still have to pay the tax when you file your tax return.) If you’re in a desperate situation, rolling the money into an IRA and then taking the full amount out of the IRA might be a way to get 100% of the distribution. This strategy may be valuable for people in low tax brackets or who know they’re getting refunds. (See what tax bracket you're in.)
You can take out up to $10,000 for a first-time home purchase. If that's why you need this cash, converting to an IRA first may be a better way to access it.
School costs could qualify. Withdrawals for college expenses could be OK from an IRA, if they fit the IRS’ definition of qualified higher education expenses .
Consider the costs of cashing out your 401(k)
“Anytime you take early withdrawals from your 401(k), you’ll have two primary costs — taxes and/or penalties — which will be pretty well-defined based on your age and income tax rates, and the foregone investment experience you could have enjoyed if your funds remained invested in the 401(k). This total cost should be considered in detail before making early withdrawals,” Harding says.
It's a good rule of thumb to avoid making a 401(k) early withdrawal just because you're nervous about losing money in the short term. It's also not a great idea to cash out your 401(k) to pay off debt or buy a car, Harding says. Early withdrawals from a 401(k) should be only for true emergencies, he says.
Even if you manage to avoid the 10% penalty, you probably will still have to pay income taxes when cashing out 401(k)s. Plus, you could stunt your retirement.
“If you need $10,000, don’t make it $15,000 just in case,” Harding says. “You can’t get it back in once it’s out.”