401(k) Early Withdrawal // 11 Ways To Cash Out Without Penalty

If you are in financial need, it might seem extremely tempting to simply withdraw some money from your 401(k), IRA, or other retirement account to cover the need. However, that withdrawal generally comes with a heavy penalty of 10% of the withdrawal amount. Retirement accounts are intended to be used for retirement, so the IRS imposes this penalty to discourage you from withdrawing money from your retirement savings. But what if you are in a true financial hardship? When can you withdraw from your 401(k) without this penalty? In some cases, you might be able to take some cash from your 401(k) without a penalty. Here is everything you need to know about early withdrawals from your 401(k) plus some ways that you can cash out without a penalty.

Understanding Early Withdrawal From A 401(k)

A 401(k) is a retirement plan that allows you to make tax-deferred contributions into the plan and lets the investments grow tax-free until retirement age. Since this money is supposed to be for retirement, then it needs to remain in the account until you retire. Withdrawing money from your account should only be done in emergency situations. Removing the money early will result in payment of income taxes and a penalty.

Since a 401(k) is an employer sponsored plan, then your employer sets some of the rules regarding early withdrawal. Not every plan allows for early withdrawals. You should first check your plan documentation to determine whether an early withdrawal will be allowed from your plan. You can also view the details of what qualifies for an early withdrawal and any documentation that may be required.

You should think long and hard before taking any early withdrawals from your plan. You could consider other options such as a personal loan or borrowing from friends or family. Once you pay the income tax and early withdrawal penalty on your funds, you are likely to only be left with about 60% of the money that you removed from your account. This can put a huge dent in your account and set you way back in your retirement planning goals.

Once you decide that you absolutely must raid your 401(k) account to get money, then consider all the options available to you. Perhaps there is a way that you can withdraw the money penalty-free. Some 401(k) plans allow for loans or other types of withdrawals that do not come along with the big penalty that most early withdrawals incur. Here are 11 ways that you can get money from your 401(k) without a penalty.

1. CARES Act Withdrawal

Due to the financial crisis created by the Coronavirus pandemic, the CARES Act was signed into law by President Donald Trump in March 2020. Among the provisions of this act were some situations which allow for penalty-free withdrawals from your 401(k) in 2020 due to COVID-19. There are a few ways to qualify for a withdrawal under this act. If you or your spouse were diagnosed with COVID-19, then you would qualify. Next, if you experience adverse financial consequences due to being furloughed or laid off because of COVID-19, then you would qualify. Finally, if you are unable to work due to a lack of childcare or your own business suffers financial hardship due to COVID-19, you will be qualified.

If you qualify and take the withdrawal during 2020, then the 10% penalty for early withdrawal will be waived. You will still owe income taxes on the withdrawal, although you can spread out the taxes over three years. For example, if you withdraw $12,000 from your 401(k), you can choose to claim $4,000 of income in 2020, 2021, and 2022. You may also choose to claim the entire amount in the year in which you receive the distribution.

2. Avoid The 401(k) Early Withdrawal Penalty

While the age for avoiding the penalty is normally 59 1/2, there is an exception to the age rule. If you leave a job or are terminated at age 55 or later, then you can make withdrawals from your account with that employer without paying the penalty. Make sure that you do not make withdrawals from any other plans you might have as those will still be subject to the penalty.

Likewise, remember that there are even heavier penalties for missing required minimum distributions (RMDs). Upon reaching age 72, you are required to withdraw certain amounts from your account. If you fail to make the withdrawal, then you will receive a penalty of 50% of the amount of the required distribution. Suppose you were required to withdraw $8,000 from your 401(k). If you miss that distribution, then you will owe $4,000 in the penalty alone!

3. Hardship Withdrawal

There are times when a severe financial need will be enough to allow you to take a hardship withdrawal without the 10% penalty. The things that specifically qualify as a hardship will be spelled out in your plan documentation, and those will vary between employers. However, there are a couple of conditions that must always be met to qualify as a hardship. First, you must have an immediate and heavy financial need. Next, you can only withdraw enough money to cover that immediate need. You are not allowed to withdraw extra funds for spending money, payment on a credit card, or to cushion your savings account.

Medical expenses will often qualify you for a hardship withdrawal if you do not have the funds to pay them otherwise. You will likely also qualify if you are in imminent danger of foreclosure or eviction. Education related expenses like books and tuition will typically qualify for a penalty-free withdrawal, so you might be able to get some cash from your 401(k) account if you need it for school. Finally, the purchase of a first home is another expense that can qualify you for a penalty-free withdrawal. You might be allowed to take up to $10,000 from your account to pay expenses associated with a first home purchase. You should know that in each of these scenarios, you will still be required to pay income tax on your withdrawal at the rate for your specific tax bracket.

4. Borrow From Your 401(k)

This can be a great option for those who need to use money from their 401(k) but do not want to pay the penalty. It is worth noting that not all plans allow for borrowing, and even if your plan does allow a 401(k) loan, you should only use it as a last resort. You should refer to your plan documentation for the specifics, but generally, here is how a 401(k) loan works. In most cases, there is no paperwork or documentation required to qualify for the loan. This can be a great option because there is no credit check and the loan will not appear on your credit report.

In general, you must take a minimum loan of $1,000 and the maximum amount allowed is $50,000. You can repay the loan over a period of time up to 5 years, unless you are using the money as a down payment on a home. In that case, you can extend the period up to 15 years. The interest rate on the loan is usually a couple of points above the prime rate, but the great thing is that you are essentially repaying the interest to yourself. If you leave your employer while you have an outstanding loan, then it will become due immediately. If you are unable to repay the full amount, then that amount will be taxed as an early distribution including the 10% penalty.

5. Disability

If you become disabled and unable to work, then you might be able to take money out of your 401(k) or individual retirement account (IRA) early without paying the penalty. However, not just any disability will qualify you for this exemption. To meet the rules for this exception, the IRS requires you to be “totally and permanently disabled.” So, what exactly does that mean? The definition that the IRS uses is quite similar to the definition used by the Social Security Administration when determining qualification for disability benefits. One major difference exists between the two though. To qualify for disability benefits, the disability must only last for 12 months or longer. To qualify for a waived penalty on your withdrawal, the IRS requires that the disability be permanent or last for the rest of your life.

Just because the SSA has awarded you disability benefits does not mean that you will be able to waive the penalty for your early withdrawal, but it is a good start. You will be required to submit medical documentation along with your tax returns so that the IRS can make a determination whether your condition meets their definition of a disability. They will want to see a doctor’s opinion that your disability will be permanent and that you are unable to perform substantial work of any kind. You will use IRS Form 5329 to claim this disability exemption, and you will need to submit all your medical evidence to go along with it. Again, you will still be required to pay your regular income tax on the funds that you withdraw.

6. Substantially Equal Period Payments (SEPP)

Substantially Equal Period Payments (SEPP) might be a good option if you need to withdraw money for a long term need. These payments must last a minimum of 5 years or until you reach the normal 401k withdrawal age of 59 1/2, whichever is shorter. For this reason, this is not a good option if you have a short term need like a sudden unexpected expense. You cannot withdraw funds under this method if you still work for the employer through which you have the 401(k). To calculate the amount of these payments, the IRS recognizes three acceptable methods.

Required Minimum Distribution Method

This will result in an annual payment to the recipient. The account balance is divided by the life expectancy factor of the recipient to arrive at the annual amount. The amount is recalculated each year based on the new account balance, but the life table used in the original calculation is used for the duration of the payments.

Fixed Amortization Method

With this option, the payment will be the same each year. The payment is calculated using the life expectancy table and a chosen interest rate. Once the amount is calculated, then it will remain the same each year that the payments are made.

Fixed Annuitization Method

With this option, the payment will also be the same each year. However, the calculation to arrive at the payment amount is a little different. The amount is derived from the account balance divided by an annuity factor. This annuity factor comes from an IRS mortality table and a chosen interest rate. It is again based on the life expectancy of the recipient.

7. High Unreimbursed Medical Expenses

This particular exception is similar to the hardship distributions mentioned earlier, and these medical bills might qualify you under either category. You should know that a hardship withdrawal for medical bills will not entitle you to a waiver of the 10% penalty in all cases. To qualify for a penalty-free withdrawal, the amount of the bills must be greater than 7.5% of your adjusted gross income (AGI). You must also take the distribution in the same year in which the bills were incurred. You cannot take money for estimated future bills either. The bills must be currently due for services already provided.

Also note the requirement that the bills be unreimbursed. If your insurance covers part of the bills or will reimburse you for the payments, then you cannot use money from your 401(k) to pay them. Likewise, the bills must be for you, your spouse, or a qualified dependent. You cannot use the money to pay bills for a parent, sibling, or any other family member. The limit to the amount of money you can withdraw for medical bills was recently removed, so you are allowed to withdraw as much as is needed to cover all the expenses.

8. Qualified Reservist

Certain members of the military are allowed to take a withdrawal from their 401(k) or other retirement investment accounts without incurring the 10% penalty normally associated with an early withdrawal. There are several criteria that must be met to qualify, and we will discuss those here. First, a reservist is a member of the military who is not active. However, when they are called to duty, this triggers the potential qualification to make the withdrawal. The service member must have been called to active duty after September 11, 2001. The deployment must last for more than 179 days or an indefinite period.

This exception exists to help these service members cover unexpected expenses associated with their deployment. For example, a working spouse may be left at home and unexpected childcare expenses will now be incurred. The working spouse could potentially be forced to quit work, thereby placing an undue financial burden on the household. As with the previous types of withdrawals, you should only take money from your 401(k) if absolutely necessary. Removing funds from your account will have a big effect on your retirement nest egg, and it can take years to recover from even a small withdrawal. Qualified reservists are also given the option to repay the withdrawal amount within two years of their active duty tour ending even if the amount causes them to exceed their annual contribution limit. This can be a great short-term option for those members of the military needing some extra financial assistance during their deployment.

9. Auto-Enrollment

Believe it or not, some employers will automatically enroll their employees in a 401(k) plan. In fact, the Federal government encourages auto enrollment, and that is the reason that this exception was created by the Pension Protection Act of 2006. Remember that a pension and 401(k) are different, but they both help provide income for retirees. Instead of requiring employees to opt-in to the 401(k) plan, employers can now automatically enroll employees and allow them to opt-out if they choose. This encourages saving for retirement and helps them begin to build a nest egg without them even realizing it in some cases. So, what happens to the money that is already deposited into the account when the employee decides to opt-out? You might be able to withdraw your contributions without paying that pesky 10% penalty.

If your employer has added the withdrawal option, then you will have 90 days to withdraw your own contributions from the account without the penalty. If your employer did not add this feature, then the penalty will still be due. Either way, you will still be paying your normal income tax rate on the funds.

10. Roth 401(k) Or Roth IRA Conversion

Since you can withdraw from your Roth account without a penalty at any time, you might consider converting your Traditional 401(k) to a Roth account. You might even have the option to rollover to a Roth IRA, but there are some differences between an IRA and 401(k). You should check with your plan administrator to make sure this is allowed. Also note that you will be required to pay income taxes when you make the conversion. Since you contribute to a traditional plan with pre-tax dollars and contributions to a Roth plan are with after-tax dollars, you will have to go ahead and pay taxes on those dollars when you perform the conversion. Make sure you have enough cash on hand to cover those taxes. Once the conversion is complete, you will be free to make a withdrawal from your Roth account without any associated penalties.

11. Death

A death is another way to access funds from a 401(k) without being subject to the normal 10% penalty. Obviously, you will be unable to make the withdrawal upon your death, but the penalty exemption applies to your beneficiaries as well. If you have no beneficiary listed with your plan, then the account will become part of your estate and must go through the probate process. That can take a considerable amount of time, although your heirs will still be allowed access to the funds without the penalty at the end of probate. For purposes of this discussion, we will assume that you have a named beneficiary for your account.

Your plan administrator sets up the specific withdrawal rules for how the funds will be handled upon death. While the IRS sets the general framework and rules, your plan might have more restrictive rules than what the Internal Revenue Service does. Many plans allow the beneficiary to choose whether to receive periodic distributions or a lump sum. Either way, your beneficiary can withdraw the money without a penalty even if both the deceased and the beneficiary are under age 59 1/2. Most people choose the lump sum option which means that they receive the entire account balance at once. While the penalty will be waived, you will still be required to pay income taxes on the funds, so getting a lump sum can result in a large tax bill at the end of the tax year.

If your spouse is your beneficiary, he or she has other options as well. You could perform a rollover of the funds into an IRA. This prevents you from paying income taxes on the funds until you begin making IRA withdrawals. Your financial advisor can help you decide between a Roth vs traditional IRA. You should work with the plan administrator to perform a direct rollover. This means that they will send the money directly to the brokerage where your IRA is located. If they send you a check instead, they are required to withhold 20% for federal taxes, and you must remember to deposit the check into the IRA within 60 days. This can get tricky, so things are much easier with a direct rollover. Also remember that you might be able to qualify for Social Security spousal benefits upon the death of your spouse, so that can provide additional financial resources.

The Bottom Line

While you should do everything possible to avoid raiding your retirement funds, there are some cases when it becomes necessary. You already know that you will be paying taxes on the funds you withdraw as ordinary income, but you will also be charged a 10% penalty on top of that in most cases. However, in certain situations, that penalty is waived. We have discussed several ways here that you can take an early withdrawal from your retirement savings account without being forced to pay that extra penalty. If you absolutely must withdraw that money from your account, you should try to make sure the withdrawal fits into one of the exceptions discussed here so that you can save yourself some money on the tax penalty. If you are ever unsure whether your situation qualifies for an exception, you should always consult your financial advisor for help.

Frequently Asked Questions

What are the hardship rules for 401(k) withdrawal?

The rules can vary by plan, and plan participants should always consult their plan documentation to see the specific rules that will apply. Remember that even with a solo 401(k), you should have your rules written down and documented. However, there are a couple of basic rules that will always hold true when it comes to a hardship 401k withdrawal. First, the withdrawal must be for an immediate and heavy financial need. Next, you are only allowed to withdraw enough funds to cover that immediate need. For example, missing a mortgage payment typically does not qualify as an immediate and heavy need. However, if you have received foreclosure papers and are in danger of eviction, then that constitutes an immediate and heavy need. Again, you should contact your plan administrator with any questions about the hardship requirements for your qualified plan.

What is the tax penalty for withdrawing money from a 401(k)?

It depends on when you make the withdrawal. If you are age 59 1/2 or older, then there is no tax penalty. However, if you make a withdrawal before reaching this age, you will be charged an extra 10% penalty on top of your regular income taxes that you pay on the funds. In some cases, you might be able to take a withdrawal without being required to pay the penalty. Some situations include hardship withdrawals, unreimbursed medical expenses, education related expenses, qualified reservists, and death. This is not an exhaustive list, and you should contact your financial planner to discuss your specific situation to see if you can qualify for a penalty-free withdrawal.

What are the penalties for withdrawing from my 401(k) before age 59-½?

Unless you fall into one of the special exemption categories, you will pay a penalty of 10% of the amount of funds you withdraw. This can get quite pricey and really cut into your retirement savings. If you must make a withdrawal before reaching retirement age, then make sure you check the list of exemptions to the penalty. If you can qualify under one of the exemptions, then you will not be forced to pay this extra penalty.

What’s the difference between a withdrawal and a 401(k) loan?

With a 401(k) loan, you must repay the money back into your account over a period of time. With a standard withdrawal, there are no repayment requirements. You will be charged interest on the loan, although you are technically paying the interest back to yourself. The money goes back into your 401(k) account, and you usually can spread the payments out up to 5 years. If you are using the money for a down payment on a home, you can even spread them over 15 years. A loan is usually a much better option than a withdrawal because at least you will be replacing the money. However, not all plans offer 401(k) loans, so that might not be an option for you.

Elliot Marks

Elliot Marks

Author & Social Security Advisor

Elliot Marks has spent over 10 years providing clear and concise information to help Americans navigate the complex nuances of social security and many other government services in the United States. Elliot has a passion for helping those in need of these services to be able to find timely access to news and information that is relevant and helpful to their daily lives.