401(k) Withdrawal Rules

401k withdrawal rules

A 401(k) plan is a retirement account that employers offer employees. It allows workers to save a portion of their salary each month before IRS tax withholding. Many companies calculate contributions as a percentage of the employee’s salary and put the amount in a 401(k) account for the worker before paying them. After reaching a certain age, participants can cash out their contributions for retirement.

While this process sounds easy enough, there are important rules to consider as a 401(k) contributor to avoid unnecessary penalties and missed opportunities. When can you withdraw your 401(k) portion? At what age is a 401(k) withdrawal tax-free? Can you make early withdrawals? We created this comprehensive guide to explain everything you need to know about existing and new 401(k) withdrawal rules in 2023.

401(k) Distribution Rules and Eligibility

You can typically start taking withdrawals if any of the following occurs:

  • You reach age 59 ½
  • You become disabled
  • Your employer terminates your 401(k) plan
  • Your employer terminates your employment
  • You experience a qualified financial hardship

Additionally, if you die, your beneficiaries can withdraw from your 401(k) account.

What Is the 401(k) Early Withdrawal Penalty?

While it may be tempting to withdraw your money before age 59 ½ when you’re nervous about the market or short on cash, the IRS may charge you an early 401(k) withdrawal penalty. This penalty is usually an additional 10% tax on your distribution. You may also have to pay income tax on the amount withdrawn. For example, let’s say you take out $10,000 while in the 22% tax bracket. In this instance, the IRS may request a $1,000 withdrawal penalty and $2,200 income tax, leaving you with $6,800 in total.

What Reasons Can You Use to Withdraw From Your 401(k) Without a Penalty?

Fortunately, the IRS outlines a few events that allow you to withdraw your 401(k) funds early without incurring a 10% early distribution penalty. These are generally categorized as early withdrawals or hardship distributions. Note that you will still need to pay taxes on these withdrawals. Check your plan document and summary description to ensure your 401(k) plan allows for distributions in these situations.

Early Withdrawals

An early 401(k) distribution may be penalty-free before you reach the normal retirement age stated in your plan document or before you turn 65 if you qualify for one of the following exceptions:

  • You leave your job.
  • You become disabled.
  • You become terminally ill.
  • You are a domestic abuse survivor.
  • You over-contributed to the 401(k) plan.
  • Your employer terminated your employment.
  • You split your 401(k) amount during a divorce.
  • The IRS grants relief if you experience a disaster.
  • You want to receive substantially equal payments.
  • Your employer auto-enrolled you, and you want out.
  • You adopt or give birth to a child during the year of your withdrawal.

As noted above, your beneficiaries can withdraw funds from the account if you pass away.

Hardship Withdrawals

If you find yourself in a financially tough situation and require immediate funds, the IRS may allow you to withdraw the amount needed without a penalty. Some situations that the IRS considers an immediate and heavy financial need include:

  • You want to purchase a home.
  • You need to pay funeral expenses. 
  • You require funds to pay medical bills.
  • You want to repair the damage done to your home. 
  • You need money to prevent eviction or foreclosure. 
  • You need funds to pay for post-secondary education.

You can also pay for many of these expenses for your spouse, dependents or beneficiaries.

How to Withdraw Money From a 401(k) Before Retirement

how to withdraw money from 401k before retirement

Your employer will typically have a plan administrator who determines whether you qualify for a hardship withdrawal or early distribution. You will need to explain to them why you need the 401(k) funds and have issues receiving money elsewhere. You may also need your spouse’s consent if your plan requires it. Upon receiving approval, you may withdraw your contributions and pay the necessary income taxes and penalties, if required.

How Much Can You Withdraw From Your 401(k) After 59 ½?

The 401(k) withdrawal rules state that after 59 ½, you may receive a lump-sum distribution if it is less than $5,000 or rollover your contributions into an IRA plan. You may also withdraw over $5,000 if your contributions exceed this amount. Want to continue contributing to your 401(k) after retirement? Many companies allow employees to continue earning investment income on their savings.

When Can You Withdraw From Your 401(k) Without Paying Taxes?

With a standard 401(k) plan, your withdrawals are always taxed as income. You can avoid this with a Roth account. You contribute to a Roth account after you pay taxes, so you can withdraw your money without paying taxes as long as you are over 59 ½ and have held the account for a minimum of five years.

Is a Self-Directed 401(k) Subject to the Same Withdrawal Rules as a Conventional 401(k)?

While a self-directed 401(k) plan offers a larger variety of assets than a normal 401(k), the same withdrawal rules apply to both account types. Self-employed individuals with a self-directed 401(k) can choose to invest in precious metals, real estate, cryptocurrency and private equity, among other things.

Standard 401(k) vs. Roth 401(k) Withdrawal Rules

While the IRS charges tax on withdrawals from a conventional 401(k) plan, you contribute to a Roth 401(k) account post-tax, allowing you to make tax-free withdrawals on your contributions and earnings.

401(k) Investment Options

A standard 401(k) plan offers excellent investment options like: 

  • Bonds 
  • Stocks 
  • Mutual funds 
  • Exchange-traded funds 

You can gain even more diverse investment options with a self-directed 401(k) plan, such as: 

  • Tax liens
  • Real estate
  • Trust deeds
  • Cryptocurrency

New 401(k) Hardship Withdrawal Rules 2023

As noted earlier, early distributions are subject to a 10% tax penalty unless you qualify for an exception. According to new rules in the Secure 2.0 Act, plan administrators may be required to assist you in withdrawing a certain amount from your plan if you have encountered an unforeseeable and immediate need for family or personal emergency expenses.

Stay Informed About Your 401(k) Options With Accuplan Benefits Services

stay informed about your 401k options

There are many complex rules to consider regarding 401(k) withdrawal rules. To avoid any issues along the way, discuss your options with Accuplan Benefits Services. Accuplan has an experienced team of professionals who use their vast industry knowledge and rules to help people open retirement accounts and make worthwhile investments. To learn more about your 401(k) options, contact our experts today or fill out a form to get started right away.

Our information shouldn’t be relied upon for investment advice but simply for information and educational purposes only. It is not intended to provide, nor should it be relied upon for accounting, legal, tax or investment advice.

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