Our 401ks are designed to help us save for retirement, but sometimes in life, you might come across an urgent need to withdraw from those savings.
In an ideal world, we’d leave every penny there until the day we finally leave the workforce, however as most of us know there are circumstances in life that sometimes prevent this from happening.
Is it possible then to learn how to withdraw from 401k savings without any penalties?
For those not yet old enough to qualify for access to their savings, you can expect to pay some penalties. These include various taxes and fees that you’ll be charged for getting early access to your 401k account, whether you’re only taking a portion of it or trying to use the entire amount.
There are some stipulations and rules in place that need to be considered though, as not every case is so cut and dry.
We’ll look at some common examples of when you might want to withdraw from your 401k, how to do it, and what ramifications you can expect if you end up taking funds early from this pension savings account.
How Can You Withdraw from 401k Without Any Penalties?
Knowing that you have such a large sum of money sitting there waiting for retirement can be hard for some people to fathom, and they might wonder about whether they can withdraw it early.
Getting access to these funds before your retirement age will come with penalties though, so, unfortunately, you won’t be able to take any of it out without paying in some way or another.
Taking an early withdrawal from a 401k or IRA account means you’ll be liable for penalties, and these are usually in the form of tax.
When you make contributions to your 401k account they’ll be tax-free with the understanding that tax will be charged when you start to withdraw, but if you do it early those tax rates are even higher.
Withdrawing money from your IRA or 401k before the age of 59.5 means you’ll have to pay the standard federal income tax according to your personal tax rate as well as a 10 percent penalty.
This 10 percent is based on how much money you plan on withdrawing, but not the remainder that’s left in your account.
Some states also impose further state income tax that needs to be considered depending on where you live.
Given these harsh penalties, it’s not generally recommended to take anything from your 401k account unless it’s deemed a financial emergency.
These accounts should be seen as pensions put away for retirement, and not a bank account that can be easily accessed. As the government wants to avoid people spending their retirement funds early, they impose these penalties to make it a less attractive offer.
When Can You Withdraw from Your 401k Tax Free?
As we earn money, we put a portion of it aside into our 401k accounts, and this could be done either before paying tax or after we’ve paid income tax.
Depending on your current situation and financial status, it might be wiser for you to pay income tax now rather than when you’ll be at a much higher tax bracket down the line.
Unfortunately, there’s no way to avoid paying tax on this money regardless of when you do it. However, by thinking to the future of your financial situation, you’ll be able to determine which is the more savvy option and choose that.
Your 401k balance is still classed as income so you’ll have to pay tax on it at some point even if you don’t cash out early.
When you turn 59.5 years old, your options include cashing out and withdrawing your 401k balance by paying tax on the income or rolling the money into another type of retirement account like an IRA.
However, just because the tax payment doesn’t happen right away, that doesn’t mean it’s entirely deferred, as you will need to pay it some day.
Can You Use Your 401k While You’re Still Employed?
Things happen in life that are out of our control and there might be times when you need to access the funds in your 401k even though you’re still of working age.
This is entirely possible to do, but as discussed earlier, it comes with penalties including income tax and a 10 percent fee that’s charged on the balance you take out.
Another way to withdraw money early is with a specific rule set in place by the IRS, rule 72(t), which lets people take a certain amount from their account each year depending on their age.
With the age for withdrawal being 59.5, you’re able to take more each year the closer you get to that age.
However, you must make deductions for a minimum of five years and the entire amount will be taxed as income in addition to your regular salary.
There are some hardship provisions in place with most 401k plans, depending on your provider and employer.
These might include things like funeral costs, property damage, and medical bills, however, you will need to provide proof in order to qualify.
Even though this access is granted based on financial hardship, you will still be required to pay the regular tax as well as the standard penalty for early withdrawal.
Worse still, after you get the money you’ll have to wait another six months before you can start making contributions to your 401k again.
You may be able to access the money in your 401k is by taking out a loan while you’re still working, but this will depend on the options your plan offers.
The most common offering is being able to use up to 50 percent of your current balance, up to a maximum of $50,000, with this amount changing periodically.
You’ll be required to make payments out of your paycheck to put the money back in, so it won’t be gone forever.
One caveat to consider with this approach is that by taking the money out of your 401k, even just for five years, you won’t be earning interest on it.
Any investment options you’ve chosen will only be applied to the money in your 401k and it can have quite a serious impact over those years.
Therefore, it’s usually better to apply for a personal loan elsewhere so that it doesn’t affect your savings plan.
What to Consider When Withdrawing from Your 401k
Most people think about withdrawing from their 401k early because of serious circumstances or they can’t stand the thought of that money sitting there and not being used.
These funds should be seen as a savings vehicle for retirement and a pension fund, so the longer you can leave the money there, the better it’ll be.
Here are some things to consider before you take the serious step of withdrawing from a 401k account:
Know that there are other options
No matter what type of financial situation you’re in, there are plenty of ways you can look for help before you consider touching your precious retirement savings.
Speak to various creditors, financial institutions, or financial aid organizations to see what options you have and only ever treat a 401k as your last resort.
You might be able to get a 401k loan
If you feel your only choice is to take money from your 401k, at least establish whether or not a loan is possible.
You will miss out on any interest earned over this period and will have to pay it back, but it usually works out better than paying income tax as well as the harsh 10 percent penalty.
Those who want to take money from their 401k before they reach 59.5 might choose to roll over the funds into an IRA account instead.
You will still be liable for the income tax on the money that you deduct, and in most cases, you will have to pay the 10 percent penalty, but there are exceptions.
People with medical bills, disability and death situations, first home buyers, or those with medical insurance premiums to pay may be exempt from this 10 percent if they withdraw from their IRA instead.
401k accounts are protected from bankruptcy
If you’re faced with serious financial hardship it might be tempting to take money from your 401k to cover the costs.
However, most states have legislation in place that means even in the face of bankruptcy, your 401k account is safe and can’t be touched.
Therefore, it’s better to leave it there so you have something to rely on down the line even if things seem difficult right now.
Cost of living at retirement
It’s easy to discount how much money we’ll really need when we retire, and it can be hard to determine what the cost of living will even be by then.
Sit down and prepare a budget for the future to think about what the actual costs might be when you retire and you will likely get a wake-up call about what your 401k savings are so important.
Understanding the 401k savings retirement plans can be tricky, and they get even more confusing if you’re planning on withdrawing from them early.
These are the answers to some common questions regarding 401k withdrawal and what it could potentially mean for your money.
How Do You Pay the Penalty For Early 401k Withdrawal?
If you decide to withdraw early and agree to pay the penalties, this can be automatically deducted from your current 401k balance.
There’s no need to make a separate payment after the withdrawal as it can be taken for you by a plan provider.
How Often Can You Take a Hardship Withdrawal From a 401k?
Depending on your employer and plan, there will be limits to how often you can withdraw from a 401k based on hardship.
You will also be limited in the contributions you can make after a withdrawal, with a six-month ban on contributions usually put in place once you’ve taken the money.
Can You Use 401k To Buy a House?
Choosing to use some of your 401k for the down payment on a house will still make you eligible for penalties as well as the standard income tax for your bracket.
A Roth IRA is considered the best account to take funds from for a house deposit because of the lower taxes and penalties.Last updated on: