Key Points
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There’s typically a 10% early withdrawal penalty if you take money out of your 401(k) before turning 59 1/2.
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The IRS does offer some exceptions to this rule.
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Even if you qualify for an exception, you’ll still owe ordinary income taxes on your distribution.
When you need money in a hurry and you don’t have enough cash on hand, dipping into your 401(k) might seem like the logical option. There’s no need to deal with loan paperwork, and you don’t have to pay the money back if you don’t want to.
But if you’re under 59 1/2, taking money out of your 401(k) comes with a hefty tax bill. In addition to owing income tax on your withdrawals, you could also face a 10% early withdrawal penalty — unless you qualify for one of these exceptions laid out by the IRS.
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How to avoid the 10% early withdrawal penalty on your 401(k)
You may be able to avoid the 401(k) early withdrawal penalty if one or more of the following apply to you:
- You’ve recently given birth or adopted a child (up to $5,000 per child).
- You’re totally and permanently disabled.
- You sustained an economic loss in a federally declared disaster (up to $22,000).
- You’re a victim of domestic abuse (up to the lesser of $10,000, or 50% of the account).
- You need to cover an emergency expense (up to the lesser of $1,000 or your vested account balance over $1,000, limit once per calendar year).
- You’re taking substantially equal periodic payments (SEPPs).
- You’re paying for medical expenses in excess of 7.5% of your adjusted gross income (AGI).
- You’re a qualified military reservist called to active duty (certain distributions only).
- You leave your employer in the year you turn 55 (or 50 if you’re a public safety worker).
- You have a terminal illness.
Note that even if you qualify for one of these exceptions, you’ll still owe ordinary income taxes on any withdrawals, unless the money comes from a Roth 401(k). In the latter case, a portion of your withdrawal will be tax-free. The exact amount depends on how much of your account balance is made up of personal contributions versus earnings.
For example, say you have a $10,000 Roth 401(k) balance made up of $9,000 in contributions and $1,000 in earnings. If you want to make a $1,000 withdrawal, 90% ($900) of the withdrawal would be tax-free, but you’d owe tax on the remaining $100 that represents the share of the withdrawal composed of earnings.
Alternatives to an early 401(k) withdrawal
Tapping your 401(k) has its advantages, especially if you qualify for one of these exceptions. But it also sets you back when it comes to your retirement savings. If you’d rather avoid that, it’s worth exploring other options before you decide to make a 401(k) withdrawal.
If you face an unexpected expense and you owe a creditor, you could try the following:
- Setting up a payment plan: Some creditors will let you pay your bill in installments over time so you don’t have to come up with a large chunk of cash at once.
- Negotiating with the creditor: You may be able to settle your debt by offering to pay a lump sum and asking the creditor to treat it as full payment.
- Taking out a loan: You can use a personal loan for just about anything, and you don’t have to put up any collateral.
- Borrowing from friends or family: Just make sure you agree on a repayment plan, and put everything in writing.
If you hope to retire early or to use the money to make a big purchase, you might try:
- Saving up over time: Budget a certain amount of money to set aside for the item over time, and leave your 401(k) alone for now.
- Stashing some money in a taxable brokerage account: These accounts don’t offer the same tax advantages as 401(k)s, but they also don’t have any early withdrawal penalties.
- Taking out a loan: A loan can also work well for a large purchase, like a major home repair or new car.
- Taking a 401(k) loan: Some 401(k)s enable you to borrow against your balance and pay back what you owe with interest over time.
You may still decide that a 401(k) withdrawal is the way to go, and that’s OK. Just make sure you’ve reviewed all the options available to you, and you’re comfortable with the tax consequences of your choice.
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