For which reasons can you take a 401(k) withdrawal without penalty?
If you need to take money from your 401(k) account, you have options. You may be able to:
- Apply for a hardship, or unforeseen emergency, withdrawal by meeting certain requirements
- Request a loan, if your plan allows for it
- Take a withdrawal from your account—although you may have to pay a penalty if you’re younger than 59½
If you take a withdrawal, you may be subject to a 10% early withdrawal penalty. That means you’d owe a $1,000 penalty fee to the IRS for a $10,000 withdrawal from your retirement account. But you can avoid this penalty if you meet one of several exceptions provided by the IRS.
You avoid the 10% penalty if you’re younger than 59½ and by meeting one of the following exceptions that apply to both qualified plans, such as 401(k)s, 403(b)s, and others, and individual retirement accounts (IRAs):
- Total and permanent disability
- Unreimbursed medical expenses that exceed a certain percentage of your adjusted gross income
- A series of substantially equal payments—you commit to taking payments for five years or until you reach age 59½, whichever comes second (payments must begin after separation from service in qualified plans)
- An IRS levy on your account
- Certain withdrawals to qualified military reservists called to active duty
- Rollover the amount to another retirement plan or IRA, or convert pretax money to after-tax (Roth) money
Qualified plans have a few additional exceptions that will avoid the penalty, including:
- Corrective distributions from putting too much money into your plan for the year (there are annual IRS limits to how much you and your employer can contribute to your plan)
- Qualified domestic relations orders—splitting of your retirement account between yourself and your former spouse as part of a court order
- Dividends received from employee stock ownership plans
- Separation from service during or after the year you reach age 55 (age 50 for certain public safety employees)
Similarly, IRAs have a few exceptions that qualified plans don’t, such as:
- Qualified higher education expenses
- Qualified first-time homebuyers, up to $10,000
- Health insurance premiums paid while unemployed
Roth IRAs have a five-year rule for withdrawals
You should also be aware of the five-year rule for Roth IRAs. You must wait five years from January 1 of the tax year you opened your Roth IRA to avoid the 10% penalty. You can make penalty-free withdrawals of your contributions at any time. This rule applies to Roth IRA earnings, money converted from pretax to Roth, and inherited Roth IRAs. Each time you convert money from pretax to Roth, you start a new five-year clock, but for non-converted Roth money, you only need to reach the five-year mark once. After that, you can withdraw from all non-converted Roth IRAs you own without penalty.
You must take required minimum distributions
Take required minimum distributions (RMDs) when you’re required—typically after reaching age 72 or when you retire, whichever comes second—or you may be subject to a different, more substantial tax. If you don’t take the full amount of your RMD, you’ll be subject to a 50% tax on amounts not withdrawn. Let’s say you have a $10,000 RMD for the year, but you only withdraw $6,000. Your penalty will be $2,000—50% of the $4,000 you didn’t take out.
Know the rules to avoid early withdrawal penalties
Remember to read your retirement plan’s summary plan description or plan highlights document to understand the rules specific to your plan. Your plan’s conditions for withdrawing money may differ from what the IRS allows.
This content is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.