Can retirement plan withdrawals be paid back?

Whether you’re working or retired, federal regulations don’t typically allow you to repay money you’ve withdrawn from an employer-sponsored retirement plan. Here’s a look at the potential cost of a plan withdrawal and some alternative ways to tap your retirement assets for an urgent need while reserving the possibility to pay it back later.

When it comes to taking money out of your employer-sponsored retirement plan, it’s generally a permanent decision. If you qualify for a withdrawal, you get your requested cash, minus a minimum 20% federal tax withholding. You then must deal with the current year income taxes and, if you’re not yet 59½, the possible 10% penalty that will be triggered.

Unfortunately, you’re also left with an immediate reduction in your retirement savings. Because under the current regulations that control employer-sponsored plans, there are no provisions for paying it back directly unless it’s a special, limited type of withdrawal.¹

The potential cost of a 401(k) account withdrawal

When you withdraw money from your retirement saving plan today, you also sacrifice the potential value of those savings. Thanks to compound, tax-deferred growth, this could be substantially more than your original withdrawal amount.

Paybacks for a special withdrawal permitted under the CARES Act were recently allowed—but only for a while.

As part of the CARES Act, which was enacted by Congress in 2020 to provide varied relief due to the coronavirus pandemic, 401(k) qualified plan participants could temporarily make withdrawals from their 401(k) plan (provided they were permitted under the plan) that were eligible for payback.

These COVID-related distributions (CRDs) were created to offset financial difficulties related to the pandemic. Plan participants who took CRDs have three years to pay back these CRDs and potentially avoid paying income taxes and penalties on these distributions.

The window opened for CRDs on January 1, 2020, and closed on December 30, 2020. The three-year period to repay all or a part of a CRD is quickly approaching.

Alternatives for people who prefer a payback option

If you need immediate cash and want to minimize the potential impact on your retirement savings, you may have a couple options.

Consider a plan loan—Many 401(k)s let you borrow from your account, usually for a term of five years and at an interest rate set by the plan. Repayment comes directly out of your paycheck—and the entire amount, including interest, goes back into your retirement plan account. Information about the loan’s interest rate, number of loans available at one time, any loan origination and maintenance fees, repayment terms, and whether repayments are allowed after you’ve left your employer, among others, will depend on your plan. You’ll want to check your summary plan description (SPD) or plan highlights to see which options your plan includes.

Use your IRA—The ability to take withdrawals from IRAs is less strict than those for 401(k)s, including no hardship required for withdrawals before age 59½. Any withdrawals are still subject to taxation and a potential 10% early penalty if taken before age 59½. But you can always make new contributions to your IRA, subject to the yearly IRS limits. In addition, any withdrawals of Roth contributions (not earnings) from a Roth IRA aren't subject to taxation.²

Increase your paycheck contributions following a withdrawal from your 401(k) plan—If you take a 401(k) withdrawal and are an active employee, you may consider increasing your contributions to your 401(k) plan, subject to IRS and any plan limits, in an effort to replace the amount withdrawn back to your account. You will, however, still miss out on the tax-deferred growth potential of any amounts that were withdrawn.

Consider the big picture before you make a 401(k) withdrawal

While a 401(k) plan can be used to build long-term retirement savings, it’s not intended to be used as a bank for short-term cash availability. Once you withdraw your money, you generally can’t pay it back. 

Before you turn to your retirement accounts for financial relief, make sure you understand the pros and cons. Consider reaching out to a tax advisor or financial professional to discuss the tax consequences and retirement planning impact of an early withdrawal.

1 This excludes exceptions for coronavirus-related distributions, qualified birth or adoption distributions, and qualified disaster distributions. 2 Special rules apply to tax-free distributions of Roth earnings.

Income-tax rules on how withdrawals are handled may vary from state to state.