When Can I Take Money Out of My 401(k)?
When Can I Take Money Out of My 401(k)? In this post, we explain when you can remove money from your 401(k) and what the potential tax consequences are when you do.
As of June 2023, there was a little over $7.2 Trillion held in American 401(k) accounts.
This is 2nd place to IRAs which held about $13 Trillion, but many IRAs are funded with rollovers from 401(k)s.
In any event, there can be little doubt that 401(k) plans are the primary retirement asset builder for working Americans.
When their tax-deferred growth is coupled with the potential for employer contributions, 401(k) accounts are a potent wealth-building weapon.
Eventually, if you’ve done a good job saving, you’re going to want to get your hands on some of that hard-earned cash.
And you should. It is your money after all.
However, the government doesn’t give us access to these tax-advantaged vehicles without also establishing some rules that can inhibit our access to them.
Let’s discuss several options for when you can withdraw money from your 401(k), the tax implications of those options, and how you can potentially avoid penalties that would otherwise make 401(k) withdrawals unattractive.
1) Anytime
To begin, you can take distributions from your 401(k) at any time, for any reason.
However, if you do this before you turn 59.5 years old, you’ll owe a 10% early withdrawal penalty for anything you take out of the account.
There are some exceptions which we’ve written about below, but the fact is early withdrawals are not an ideal financial decision.
If you can delay withdrawals from your 401(k) until you reach age 59.5, you should.
2) After you turn 59.5
So, what about after you turn 59.5?
Well, after you turn 59.5, you can make withdrawals at any time, for any reason, penalty-free.
Just keep in mind that penalty-free does not equal tax-free. For any tax-deferred assets in the account, you will have to pay income tax on your distributions.
You should also be thinking about required minimum distributions (RMDs) once you reach this age.
Ready or not, the government will begin requiring that you take distributions from your 401(k) when you turn 73 or 75 (depending on when you were born).
There are strategies for mitigating the effects of RMDs which you can read about in this post.
3) After you turn 55
I promised you we’d have exceptions!
Once you turn 55 you can begin making penalty-free withdrawals from your 401(k) when you sever employment with the employer that sponsors the plan.
In other words, if you retire or get fired at age 55 or later, you can start making penalty-free withdrawals from the 401(k)-plan associated with that employer.
It’s called the rule of 55 and it’s an excellent tool for early retirees.
Keep in mind that you can only use the rule of 55 after you turn 55. You can’t retire at age 54 or earlier and begin making withdrawals after you reach age 55.
You also can’t tap into a 401(k) from a previous employer but you could possibly roll an old 401(k) into your current one, and then use the rule of 55 to access those funds early.
Finally, your employer-sponsored 401(k) may not allow you to use the rule of 55 so be sure to check out your plan documents to confirm before you make plans around this strategy.
4) Anytime with Rule 72T
Another path for accessing your 401(k) early is to use Rule 72T which is also known as a Series of Equal Periodic Payments (SEPP).
Under rule 72T you can begin making penalty-free withdrawals from a 401(k) at any time assuming you continue those distributions for at least five years or until you turn 59.5, whichever occurs later.
So, if you start a 72T at age 52, you’ll have to keep it up until you reach age 59.5.
If you start at age 57, you’ll need to keep taking distributions until age 62.
Rule 72T also applies to 403(b)s and IRAs and the methods for calculating distributions can be complicated.
If you elect to go this route, I highly recommend reaching out to a tax professional for help. Fumbling the process can lead to a costly tax bill so you definitely don’t want to get it wrong.
5) Hardship Withdrawals & Exceptions
In addition to the paths we’ve already presented, the IRS does allow one to make withdrawals from a 401(k) for the following reasons:
- Beginning in 2024 you can withdraw up to $1,000 for special emergencies and repay it over the course of up to three years.
- Also beginning in 2024, you can withdraw up to the lesser of 50% of your 401(k) balance or $10,000 if you are a domestic abuse survivor.
- You are a victim of a disaster.
- You are terminally ill.
- You are a military reservist called to active duty.
- You are disabled or become disabled.
- You gave birth to or adopted a child (up to $5,000).
Also, you can make penalty-free withdrawals if you have an “immediate and heavy financial need” for any of the following hardships:
- Some medical expenses
- To make repairs to your principal residence after a natural disaster
- Home-buying expenses for a principal residence
- Expenses to prevent foreclosure
- Up to one year of tuition and fees for post-secondary education
- Burial expenses
Bear in mind your plan may or may not allow hardship withdrawals and you won’t qualify if you have other assets you could use to pay for any of these needs.
You are also only allowed to withdraw an amount to satisfy the need. You can’t use a medical bill of $10,000 to justify removing $20,000 from your 401(k).
6) 401(k) Loans
Finally, you can withdraw money from your 401(k) in the form of a loan.
A 401(k) loan is a loan to yourself from your 401(k) plan at an interest rate that is usually 1%-2% over prime.
This rate is normally lower than those for personal loans of similar value.
You are allowed to borrow up to the lesser of $50,000 or one-half of your vested 401(k) balance and usually have up to 5 years to repay the balance.
Most employers offer an option to repay the debt using payroll deductions making repayment relatively simple.
Some of the downsides of 401(k) loans include fees (usually around $50-$100) and the fact that repayment must be made using after-tax dollars meaning the tax-deferred benefit disappears for the amount you borrowed.
Even more concerning is the fact that failure to repay the loan within the required time frame will result in the entire loan amount being treated like a taxable distribution with early withdrawal penalties (if applicable).
You don’t want to be late on those repayments.
Finally, if you have an outstanding 401(k) loan, changing employers becomes a bit of a challenge. You will be required to repay the remaining balance of your loan when you leave or shortly thereafter.
It would be a shame to have to decline a new job that you’d really enjoy because you didn’t have the cash in hand to repay your 401(k) loan.
Personally, I’d avoid 401(k) loans if possible.
Conclusion
As the balance in your 401(k) grows it’s only natural to stumble upon ways you could swiftly put that money to use.
Try to keep in mind that 401(k)s are for retirement. If you remove money from them that’s money that won’t be there for you down the road.
If at all possible, leave your 401(k) alone and try to find other sources for cash. Your 60+ year-old self will thank you.
