Best Ways to Use Your 401(k) Without a Penalty

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Matthew Etter, CFP®

Partner, President
Signet Financial Management
Daniel DiVizio profile photo

Daniel DiVizio, CFP®, CRC®

Financial Planning Director, Wealth Management
Christopher Berté profile photo

Christopher Berté, CFP®

Managing Director, Signet Financial Management Southwest Florida
Contact Now

For those who invest in their 401(k) plan, the traditional thinking is to wait until retirement before taking distributions or withdrawals from the account. If you take funds out too early, or before the age of 59½, the Internal Revenue Service (IRS) could charge you with a 10% early withdrawal penalty plus income taxes.1

However, life events can happen, which might put you in a position where you need to tap into your retirement funds earlier than expected. The good news is that there are a few ways to withdraw from your 401(k) early without incurring a penalty from the IRS.2


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  • If you are in dire need of funds, you may be able to tap into your 401(k) funds without penalty, even if you're under 59½.
  • If you qualify for a hardship withdrawal, certain immediate expenses won't incur a tax penalty, including education, healthcare, and primary residence expenses.2
  • You may also be eligible to take a loan from your 401(k), which incurs neither penalty nor taxes, but the loan must be repaid.3
  • There are also special circumstances where you can withdraw funds penalty-free from a recent employer if you have reached the age of 55.
  • You can take normal distributions from your 401(k) once you reach age 59½.

Taking Normal 401(k) Distributions

But first, a quick review of the rules. The IRS dictates you can withdraw funds from your 401(k) account without penalty only after you reach age 59½, become permanently disabled, or are otherwise unable to work.2 Depending on the terms of your employer's plan, you may elect to take a series of regular distributions, such as monthly or annual payments, or receive a lump-sum amount upfront.

If you have a traditional 401(k), you will have to pay income tax on any distributions you take at your current ordinary tax rate (because you got a tax break on the contributions at the time you made them). However, if you have a Roth 401(k) account, you've already paid tax on the money you put into it, so your withdrawals will be tax-free. That also includes any earnings on your Roth account.4

After you reach a certain age, you must generally take required minimum distributions (RMDs) from your 401(k) each year, using an IRS formula based on your age at the time.5 The RMD age was increased from 72 years old to 73 years old as part of SECURE 2.0 passed at the end of 2022.6 If you are still actively employed at the same workplace, some plans do allow you to postpone RMDs until the year you actually retire.

In general, any distribution you take from your 401(k) before you reach age 59½ is subject to an additional 10% tax penalty on top of the income tax you'll owe.1

Making a Hardship Withdrawal

Depending on the terms of your plan, however, you may be eligible to take early distributions from your 401(k) without incurring a penalty, as long as you meet certain criteria. This type of penalty-free withdrawal is called a hardship distribution, and it requires that you have an immediate and heavy financial burden that you otherwise couldn't afford to pay.7

The practical necessity of the expense is taken into account, as are your other assets, such as savings or investment account balances and cash-value insurance policies, as well as the possible availability of other financing sources.

What qualifies as "hardship"? Certainly not discretionary expenses like buying a new boat or getting a nose job. Instead, think along the lines of the following:

  • Essential medical expenses for treatment and care
  • Home-buying expenses for a principal residence
  • Up to 12 months worth of educational tuition and fees
  • Expenses to prevent being foreclosed on or evicted
  • Burial or funeral expenses
  • Certain expenses to repair casualty losses to a principal residence (such as losses from fires, earthquakes, or floods)7

The home-buying expenses part is a bit of a gray area. Generally, it qualifies if the money is for a down payment (especially if putting up the cash will help you get a mortgage) or for closing costs.2

Hardship Loan Terms

Hardship distributions are only allowed up to the amount you need to relieve the financial hardship. Withdrawals exceeding that amount are considered early distributions and are subject to the 10% penalty tax.7 Any hardship distribution you wish to take must be approved by your plan administrator. You will still owe income tax on your distribution, although, in the case of a Roth 401(k), only a portion of the distribution may be taxable.7

As a result of the COVID-19 pandemic, the CARES Act provided additional flexibility related to hardship withdrawals made during Jan. 1 and Dec. 31, 2020.8 If your withdrawal occurred during this time period, consult with a qualified tax professional, or the IRS to determine any tax and repayment options that may be available.

Requesting a Loan From Your 401(k)

If you do not meet the criteria for a hardship distribution, you may still be able to borrow from your 401(k) before retirement, if your employer allows it. The specific terms of these loans vary among plans. However, the IRS provides some basic guidelines for loans that won't trigger the additional 10% tax on early distributions.9

Whether you can take a hardship withdrawal or a loan from your 401(k) is not actually up to the IRS, but to your employer—the plan sponsor—and the plan administrator; the plan provisions they've established must allow these actions and set terms for them.10

For example, a loan from your traditional or Roth 401(k) cannot exceed the lesser of 50% of your vested account balance or $50,000. Although you may take multiple loans at different times, the $50,000 limit applies to the combined total of all outstanding loan balances.3

401(k) Loan Terms

Any loan you take from your 401(k) has to be repaid within five years unless it is used to finance the purchase of your primary residence. You must also make payments in regular and substantially equal installments. For employees who are absent from work because they're in the armed forces, the loan term is extended by the length of their military service, without penalty.11

Like other types of financing, loans from a 401(k) require the payment of interest. However, the interest you pay is deposited back into the 401(k) and treated as investment income.11 This means that instead of paying a bank for the privilege of borrowing money, you will pay yourself, eventually increasing your total balance.

One big caveat to bear in mind: If you lose or resign from your job, you will have to pay back the loan by the due date of your federal income tax return, including extensions.12

SEPP Program

IRA owners can take an early distribution without penalty as part of IRS rule 72(t), which allows distributions before the age of 59½ under the substantially equal periodic payment (SEPP) program. However, if you're still employed with the company that has your retirement plan, SEPP withdrawals are not permitted from the qualified retirement plan.13

If you no longer work for the company that has your 401(k), you can qualify for the SEPP exception to the tax penalty. The money can come from an IRA via SEPP at any time. The distributions are formulated as a series of substantially equal periodic payments over your life expectancy using the IRS tables.13

However, once SEPP payments begin, you must continue for a minimum of five years or until you reach the age of 59½, whichever comes later. In other words, if you began the SEPP at age 45, you would need to continuously take distributions until age 59½. If you fail to meet the program's requirements, the 10% early tax penalty will be applied, and you might also owe penalties for distributions in past tax years.13

The SEPP program can be helpful for those who had a life-changing event and need the money earlier than they had expected. SEPP can also help those who are close to retirement and want to begin distributions before the age of 59½. However, it's important to note that you might deplete your retirement savings too soon if you begin the SEPP program too early.

The Rule of 55

If you lost your job or retire when you're age 55 but not yet 59½, you might be able to take distributions from the 401(k) without the 10% early withdrawal penalty. The IRS allows an employee—who has been separated from their employer—to receive a penalty-free distribution from the qualified plan in the year of turning 55 or older.14

However, this only applies to the 401(k) from the employer you just left, not any earlier employer plans, nor any of your individual retirement accounts (IRAs). For your other accounts, you would have to wait until age 59½ to take distributions penalty-free.

Rule of 55

An exception to the early withdrawal tax penalty exists if the distribution is made after separation from your company's service if the separation occurred during or after the calendar year in which the participant reached age 55.15

However, if you transferred or rolled over your IRA funds from your previous employer into your current 401(k) before you retire at age 55, those funds would qualify for penalty-free distributions.15 You must also check with your retirement plan administrator since not every defined contribution plan allows withdrawals earlier than 59½.

What Taxes Will I Pay If I Withdraw My 401(k)?

In most cases, the penalty assessed on early withdraws of a 401(k) is 10%. This additional tax is in addition to having to pay tax on the withdrawal as necessary.

Can I Close My 401(k) and Take the Money?

When you resign a position or are let go, you retain control over your 401(k) account. This means you can close your existing account, roll funds over into a different retirement account, or withdraw the money. If your 401(k) is not rolled over correct and you are not eligible to make distributions from these funds, you will be subject to Federal taxes and the 10% penalty.

Do I Need to Show Proof for a Hardship Withdrawal?

Sort of. In 2015, there was a change in the rules required for what substantiation an employee had to show their employer for a hardship withdrawal. Today, individuals may self-certify their hardship. This means individuals often do not need to substantiate with the account administrator to withdraw funds.

The other side to this is the IRS may subject an employee to an audit. If the 401(k) plan is to be audited, the agent would ask the employer to substantiate the hardship withdrawal. In general, an employer should notify an employee that the employee must retain records and agree to make them available upon request to prove a hardship withdrawal is valid in the eyes of the IRS.

Do I Lose My 401(k) If I Get Fired or Laid Off?

Individual contributions into a 401(k) belong to the employee. When the employee leaves a company (either willingly or through elimination), the employee often retains ownership of those funds and can roll those into a different retirement account.

Employees may also have received employer matching contributions during their tenure with the company. Many times, these contributions have vesting schedules, meaning an employee retains ownership as long as they are employed with a company for a specific period of time. Should an employee depart from a company prior to having achieved partial or full vesting, a portion or all of the employer's contributions would be foregone and not retained by the employee.

The Bottom Line

The simplest and best way to tap your 401(k) without incurring a tax penalty is to use it for the purpose it was intended for—providing retirement income. However, if you need money for a major expense, such as important medical treatment, a college education, or buying a home, you may be eligible for a hardship distribution or 401(k) loan.

Article Sources:

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  1. Internal Revenue Service. "What if I Withdraw Money from My IRA?"
  2. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."
  3. Internal Revenue Service. "Retirement Plans FAQs Regarding Loans."
  4. Internal Revenue Service. "Traditional and Roth IRAs."
  5. Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)."
  6. United States Congress. "H.R. 2617."
  7. Internal Revenue Service. "Retirement Topics - Hardship Distributions."
  8. Internal Revenue Service. "Coronavirus-related Relief for Retirement Plans and IRAs Questions and Answers."
  9. Internal Revenue Service. "Grab the Money and Run? Retirement Plan Loans and Hardship Distributions."
  10. Internal Revenue Service. "Retirement Plans FAQs Regarding Hardship Distributions."
  11. Internal Revenue Service. "401(k) Resource Guide - Plan Participants - General Distribution Rules."
  12. Internal Revenue Service. "Retirement Topics - Plan Loans."
  13. Internal Revenue Service. "Substantially Equal Periodic Payments."
  14. Internal Revenue Service. "Retirement Topics - Significant Ages for Retirement Plan Participants."
  15. Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions from Retirement Plans Other Than IRAs."

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Matthew Etter profile photo

Matthew Etter, CFP®

Partner, President
Signet Financial Management
Daniel DiVizio profile photo

Daniel DiVizio, CFP®, CRC®

Financial Planning Director, Wealth Management
Christopher Berté profile photo

Christopher Berté, CFP®

Managing Director, Signet Financial Management Southwest Florida
Contact Now