Can I Close My 401k While Employed?

A 401(k) plan serves as an important part of retirement planning for many individuals, offering a tax-advantaged way to save for the future. Contributions to these accounts, often supplemented by employer matching, grow over time. Many misunderstand the accessibility of these funds before leaving employment or reaching retirement age. While 401(k)s are designed for long-term savings, specific provisions and circumstances can allow access to these funds even while still actively employed.

Understanding 401(k) Access While Employed

Accessing 401(k) funds while still employed is restricted, as these accounts are designed for retirement savings. However, certain in-service distribution options may be available depending on the specific plan document. These options include hardship withdrawals and 401(k) loans. Not all plans offer every type of in-service access; availability depends on the employer’s plan rules.

In-service withdrawals are distributions taken while still working for the employer. A common type is a hardship withdrawal, permitted for an “immediate and heavy financial need” that cannot be met from other reasonably available assets. The IRS outlines specific reasons that may qualify as a hardship:
Medical expenses for the employee, spouse, or dependents.
Costs related to buying a principal residence (excluding mortgage payments).
Payments to prevent eviction or foreclosure.
Certain educational expenses.
Hardship withdrawals are limited to the amount needed and are not repaid.

Some plans also allow non-hardship in-service withdrawals, particularly after a participant reaches age 59½. At this age, the 10% early withdrawal penalty no longer applies, although income taxes are still due. Some plans may permit in-service distributions of amounts rolled over from a prior employer’s plan or an IRA, often without age restrictions. Availability of these options is dictated by the individual 401(k) plan’s terms.

Another method for accessing funds is through a 401(k) loan. This is not a withdrawal but a loan taken against the vested balance of the account. Employees can borrow up to 50% of their vested account balance, with a maximum of $50,000; some plans allow borrowing up to $10,000 even if 50% of the vested balance is less. These loans must be repaid within five years, or up to 15 years if used for a primary residence. Interest is charged on the loan, but payments, including interest, are repaid directly into the participant’s 401(k) account.

Tax and Penalty Implications of Withdrawals

Withdrawing funds from a 401(k) while still employed, especially before reaching age 59½, carries tax and penalty implications. Traditional 401(k) withdrawals are subject to ordinary income tax, as contributions and earnings were tax-deferred. The tax rate depends on the individual’s federal income tax bracket, and state income taxes may also apply.

In addition to ordinary income tax, a 10% early withdrawal penalty applies to distributions taken before age 59½. This penalty is imposed on the amount withdrawn, adding cost to early access. This penalty is designed to discourage using retirement funds for non-retirement purposes.

However, exceptions exist to avoid the 10% early withdrawal penalty, even if under age 59½. These exceptions include distributions made due to permanent and total disability or after the death of the account holder, where funds are distributed to a beneficiary. Other exceptions cover unreimbursed medical expenses exceeding 7.5% of adjusted gross income, qualified higher education expenses, and distributions for a first-time home purchase.

New exceptions include:
Qualified birth or adoption expenses.
Certain domestic abuse distributions.
Limited emergency personal expense withdrawals.
Withdrawals due to certain natural disasters.
Even when an exception waives the 10% penalty, the withdrawal remains subject to ordinary income tax.

Steps to Request Funds

Requesting funds from your 401(k) while employed involves steps through your plan administrator. First, contact the 401(k) plan administrator or recordkeeper. This contact can be made through your company’s human resources or benefits department, directly via the plan’s website, or by calling their customer service.

The administrator will provide specific forms and outline the requirements for either a loan or a withdrawal. Provide necessary personal information, such as your account number, reason for the request (for hardship withdrawals), and desired amount. Complete all required sections on the application forms accurately, providing any supporting documentation requested. For hardship withdrawals, this may include proof of the financial need, such as invoices or eviction notices.

Once the forms are completed, submit them through the methods specified by the administrator, such as an online portal, mail, fax, or secure email. After submission, the plan administrator will process the request. Processing time varies. Approval typically takes a few business days, with funds disbursed in five to seven business days via direct deposit. Checks may take two to four weeks.