Can You Take Money Out of Your 401k?

A 401(k) plan is an employer-sponsored retirement savings account. Its primary purpose is to help employees save for retirement in a tax-advantaged way. Contributions are typically made directly from an employee’s paycheck, often with employer matching contributions, allowing funds to grow over time. While designed for long-term savings, circumstances may arise where individuals need to access these funds before retirement.

Methods for Accessing 401(k) Funds

Accessing funds from a 401(k) plan before retirement involves various methods, each with specific eligibility requirements and conditions.

401(k) Loans

A 401(k) loan allows participants to borrow money from their own retirement account, rather than making a withdrawal. The maximum amount an individual can borrow is generally the lesser of 50% of their vested account balance or $50,000. An exception exists where a participant can borrow up to $10,000 if 50% of their vested account balance is less than that amount. These loans typically must be repaid within five years through regular payments, usually via payroll deductions.

The repayment period can be extended for loans used to purchase a primary residence. If a participant leaves their employment or fails to repay the loan, the outstanding balance can be treated as a “deemed distribution,” which then becomes subject to taxation and potential penalties. The interest paid on a 401(k) loan is credited back to the participant’s own account, distinguishing it from traditional loans.

In-Service Withdrawals

In-service withdrawals allow an employee to take distributions from their employer-sponsored retirement plan while still employed. These withdrawals are generally permitted without penalty once the employee reaches age 59½. Some plans may also allow in-service withdrawals for specific contribution types, such as voluntary after-tax contributions or rollover contributions, regardless of age.

The SECURE 2.0 Act introduced additional penalty-free in-service withdrawal options for certain situations, including federally declared disasters, terminal illness, domestic abuse, and specific personal or family emergencies. Participants should review their plan documents to understand which types of in-service withdrawals are permitted and under what conditions.

Hardship Withdrawals

Hardship withdrawals permit an employee to take money from their 401(k) to address an immediate and heavy financial need. The Internal Revenue Service (IRS) outlines specific criteria that may qualify for such a withdrawal:

• Medical expenses for the participant, their spouse, or dependents that are deductible under Internal Revenue Code Section 213.
• Costs directly related to the purchase of a principal residence, excluding mortgage payments.
• Payments necessary to prevent eviction or foreclosure on a principal residence.
• Expenses for the repair of damage to a principal residence resulting from a casualty.
• Tuition, educational fees, and room and board expenses for the next 12 months of post-secondary education for the participant, spouse, or dependents.
• Funeral expenses for a participant’s deceased family member.

Hardship withdrawals are generally not repayable to the plan.

Qualified Distributions (Post-Employment/Retirement)

The standard methods for accessing 401(k) funds occur after leaving an employer or reaching retirement age. At this point, several distribution options become available. A lump-sum distribution allows the participant to receive their entire account balance in one payment.

Alternatively, participants can opt for periodic payments over a set period or their lifetime. Another common option is to roll over the funds directly to an Individual Retirement Account (IRA) or a new employer’s qualified plan.

Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs) are mandatory withdrawals that individuals must begin taking from their traditional 401(k) accounts once they reach a certain age. For most individuals, RMDs currently begin at age 73.

The specific amount of the RMD is calculated based on the account balance and the participant’s life expectancy, as determined by IRS tables. Failing to take the full RMD amount by the deadline can result in a significant penalty, which is generally 25% of the amount that should have been withdrawn.

Taxation of 401(k) Distributions

Different types of 401(k) distributions are treated distinctly under tax law, impacting the net amount received by the participant.

Ordinary Income Tax

Most distributions from a traditional 401(k) plan are subject to ordinary income tax. When funds are withdrawn, they are added to the participant’s gross income for that tax year. The amount is then taxed at the individual’s marginal income tax rate, which depends on their total taxable income and filing status.

Contributions to a traditional 401(k) are typically made with pre-tax dollars, meaning they reduce current taxable income. The earnings on these contributions also grow tax-deferred until distribution.

10% Early Withdrawal Penalty

In addition to ordinary income tax, distributions taken from a 401(k) before age 59½ are typically subject to a 10% additional tax, often referred to as an early withdrawal penalty. This penalty is imposed by the IRS to discourage early access to retirement savings. This penalty applies to the taxable portion of the distribution.

Exceptions to the 10% Penalty

There are several specific circumstances under which the 10% early withdrawal penalty may be waived, even if the distribution occurs before age 59½. One common exception is separation from service at or after age 55 (or age 50 for public safety employees). Distributions made due to the account owner’s total and permanent disability are also exempt from the penalty.

Distributions made to a beneficiary or the estate after the participant’s death are not subject to the penalty. Payments for unreimbursed medical expenses that exceed a certain percentage of adjusted gross income can also avoid the penalty.

The IRS also allows penalty-free withdrawals for a series of substantially equal periodic payments (SEPPs), qualified reservist distributions, and distributions related to federally declared disasters or certain emergency personal expenses. Recent legislation has added penalty exceptions for victims of domestic abuse and for certain emergency expenses, such as up to $1,000 annually for unforeseen needs.

Rollovers and Tax Deferral

Direct rollovers of 401(k) funds to another qualified retirement plan, such as an IRA or a new employer’s 401(k), allow funds to continue growing tax-deferred without immediate tax consequences or penalties. For a direct rollover, the funds are transferred directly from one custodian to another.

An indirect rollover involves the funds being distributed to the participant, who then has 60 days to deposit them into another qualified retirement account. With an indirect rollover, the plan administrator is required to withhold 20% for federal income tax, which the participant must make up from other sources to roll over the full amount. If the entire amount is not rolled over within 60 days, the unrolled portion becomes taxable and may be subject to the 10% early withdrawal penalty if the participant is under age 59½.

Tax Reporting (Form 1099-R)

All distributions from a 401(k) plan are reported to the IRS on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” This form details the gross and taxable distribution amounts, any federal or state income tax withheld, and a distribution code in Box 7 indicating the type of distribution and penalty applicability. Participants typically receive Form 1099-R by January 31 of the year following the distribution.

A 401(k) loan is not reported on Form 1099-R unless it defaults and becomes a “deemed distribution.”

Roth 401(k) Distributions

Contributions to a Roth 401(k) are made with after-tax dollars. Qualified distributions from a Roth 401(k) are entirely tax-free, including both contributions and earnings.

For a Roth 401(k) distribution to be considered “qualified,” two main conditions must be met: the participant must be at least age 59½, and a five-year waiting period must have passed since the first contribution was made to any Roth 401(k) account. Distributions made before meeting these two criteria may be partially taxable on the earnings portion and potentially subject to the 10% early withdrawal penalty. Employer matching contributions in a Roth 401(k) are generally treated as pre-tax and become taxable upon withdrawal.