You work, you save, you retire – it’s the American way, right?
But what happens when you have done a good job saving and get to be one of the lucky ones to retire early – are you still subject to the IRS rules of being age 59 1/2 before you can touch your money?
Ways to claim your 401k early and penalty free :
(Side rant: what the heck is up with the IRS and these 1/2 ages anyway? This concludes my rant.)
If you are stressed about having to pay the 10% early withdraw penalty, don’t freak out just yet. The IRS – believe it or not – does allow methods to withdraw funds from your 401k without penalty. Just make sure you follow the rules before you claim your prize.
A few notes before hand…
- You always have the option to take a 401k loan (if your plan allows it). Does that mean you should take it? I’m hoping that you have ample emergency funds that you can tap first. Stated another way and more blunt: You Better have enough emergency funds. Got it? If not, make sure you know the 401k hardship withdrawal rules.
- Before you make any withdraws at of your 401k, do more than just read this post. Consult your financial advisor and/or tax professional to make sure you have your bases covered.
Another thing, the methods shared below allow you avoid the 10% penalty, but they do not….I REPEAT…..do not prevent you from having to pay the tax.
Now that we have that taken care of, let’s see how you can withdraw funds from your 401k penalty free….
1. A Visit From The Grim Reaper
Okay, I’m sure that death is probably not the option that you wanted to hear. I guess technically you don’t benefit. Rest assured your family will benefit in that they can use your retirement funds to cover burial expenses and supplement other income needs now that you’re not around.
Just make sure to update your beneficiaries << you have been warned.
2. Qualifying Disability
If you have been deemed to be disabled either buy an insurance company or Social Security, then you are entitled to withdraw from your 401k penalty free.
You’ll have to provide a disability letter to your 401k custodian to verify your status and avoid the penalty.
3. Medical Bills
A visit to the emergency room can add up really quick nowadays. Our middle son banged his head on our bathroom doorway and we found that out really quick.
CHA-CHING!
If you don’t pay them, next thing you know you have debt collectors hounding you. To avoid the penalty a few things have to occur:
- Withdraw Same Year. You have to take the money out in the same year you incurred the medical bills.
- 7.5% Rule. Take 7.5% of your AGI (Adjusted Gross Income) and that’s the to the extent that the unreimbursed medical bills that you’ll be allowed to claim penalty free from your 401k.
On a side note, it is not required to itemize your deductions to qualify for this. If you don’t know what that means, then you better pay somebody to do your taxes for you.
And if you think that I had to tap my 401k to pay for my son’s emergency room visit, get your head out of the gutter.
4. Disaster Relief
With all the storms and flooding that have hit the U.S. recently, it’s a comfort knowing that if your area is deemed for disaster relief you can tap your 401k for necessary expenditures.
5. 55 and Separated From Service
According to the IRS, those that retire early or force out may have access to their 401k early. This is their wording:
“Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55”
You can take a distribution from a qualified defined contribution plan, i.e. 401(k), and avoid the 10% penalty. A couple key things to note on doing this is that it must be from the 401(k), 457 or 403(b), to avoid the 10% penalty.
This actually happened to my father in law as his company went through a buyout and he was offered an early retirement package at the age off 55. We ended up taking a distribution from his 401k to have some cash on hand and then rolled the rest into his IRA.
Don’t miss this important point: DO NOT roll over to an IRA if you think you may need some money.
If you have already done a 401(k) rollover into a traditional IRA, you have already missed this opportunity. Once you hit the IRA and you take a withdrawal, you are then assessed a 10% penalty. Rolling to an IRA might make sense later on, but until you know for sure – don’t do it.
6. Stay Equal and Periodic With 72(t)
Another more complex strategy – that I’m not very fond of – is the little know rule of 72(t). Why am I not fond of it? Because 1. it locks you in for long time and 2. it’s too complicated for most.
What is the rule 72(t)? The rule of 72(t) states that withdrawals from your 401k have to be “substantially equal periodic payments. You must use one of the three methods that the IRS has determined and then take your payment on a set schedule for a specific time period. It is required that you take those payments for either 5 years or when you turn 59 1/2 , whichever comes later.
Example of 72(t)
Let’s say you retire at the age of 53 and you elect to do 72(t) then you must take equal payments for 7 years. If you happen to need more money during that 7 years stretch, then you’ll have to go back and pay the 10% penalty on everything taken out to that point.
Now do you see why I’m not a big fan?
If you start later on, say 56, then you’ll have to take it for 5 years till the age of 61 even though you’ve already hit 59 1/2.
401k Penalty Free Withdrawals
As you can see, there are ways to tap your 401k penalty free. Just make sure you follow the rules.
Luanne says
Hello,
I’m 63 years old and still employed. I’d like to take money from my 401(k) to pay off my mortgage and put a down payment on a new home. What sort of penalties or tax issues could I potentially face in doing this?
Jeff Rose says
Hi Luanne – If you’re still employed by the same company where you have the 401k they may not allow you to withdraw the money until you leave the company. But on the tax side, since you’re over 59.5 there won’t be a 10% early withdrawal penalty on the amount taken. You will have to pay tax on the withdrawal however, so you may want to take the money over several years to minimize the tax liability. This is even more important since you’re still working and earning money.
Patrick says
Jeff,
I am 52 and working for a Utility company in Texas, with a previous employer 401K rolled into an IRA. a bit over 400k
I wanted to withdraw from my 401K to pay off my mortgage, balance 97k. I have no children or dependants. I fear that if something happens to me health wise the government will just take what I have in the 401k and I won’t be able to use it, so why not use it for me and make my life easier now
Jeff Rose says
@Patrick Personally, I think you’re overreacting to the government taking away your 401k. If you pull the money out to pay off your mortgage you’ll then be giving the government a huge tax gift in the taxes you’ll paying from withdrawing your 401k. Either way, you have full control and can decide to pay it off if that’s the peace of mind you need.
Kaci says
We are purchasing our first home. We are trying to withdraw (hardship withdraw) from a 401k (my spouse is still employed with the company). He has elected to quit participating in the 401k. We want to withdraw monies to help with down payment. He has been trying for months! With many delays.He has provided all the documentation asked for and they have delayed saying they couldn’t open said documents etc. and never informing him they couldn’t. Which of course drug out time, and gave them time to drag out past when the payments were due, therefore not wanting to give the full amount of the hardship request. Finally after confirming they have all the documentation, they now say since the deadline for the deposits to the construction company has passed they want to confirm if we made any of the deposits and if so, we cannot receive the full amount asked for. They have asked to contact the builder personally to confirm if we had made any. It is a large well known retirement management company.
Jeff Rose says
Hi Kaci – According to the IRS withdrawing money from a 401k to purchase a house isn’t a permitted hardship, at least not to get the 10% penalty waived. Are you sure that isn’t the underlying problem?
kaci says
It actually is allowed for the costs related to purchasing a principle residence.
“Whether a need is immediate and heavy depends on the facts and circumstances. Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee’s principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.
(Reg. §1.401(k)-1(d)(3)(iii))”
kaci says
We do realize we will have to pay the 10% penalty but, shouldn’t he get the amount he requested in the first place?
Jeff Rose says
Yes Kaci, as long as the employer/plan sponsor agree. The IRS has rules on hardship withdrawals, but they leave it to the employer as to whether or not they will allow them, and specifically how. You have to work with your employer on this, there’s no way around it.
Valerie says
I no longer work because my employer couldn’t hold my job any longer so I had got 13000 what left of my 401k so on my 1099 say I had 21000 in there but 4000 was took out for taxes and 1000 for state will I get a refund check
Jeff Rose says
That sounds confusing Valerie. You won’t know about a refund until you do your taxes. The distribution will be added to your other income, and then the refund will be determined.
Sara says
Hey, Jeff.
Nice to see someone who does indeed answer the questions asked…
My husband has worked for UTC for 38 years and has just retired at the tender age of 62.
We were planning on selling out home and moving South.
He inquired about closing out his 401K with the company and was told “no problem, but you must pay 20%”…
I can’t tell you what he contributed to all those years, thinking one day, we would be living a good life with the monies saved…
Now we find we are losing a great deal…
I really believe these 401K’s are a crock and would be much smarter and richer going in a different form of savings.
There were many at UTC that had no clue, what they were getting into ,,
Jeff Rose says
Hi Sara – Are you just planning to take the money out to buy a house? If so, they have to withhold 20% for estimated income tax. If you plan to roll it over into an IRA, you need to share that with them and see if that will change the answer. Please discuss this in detail with the plan administrator and your CPA. The tax implications can be huge, either way. There are some quirky government plans that do have such a requirement.
Darren Adkins says
Hi Jeff…
I am 55 years old and will be taking early retirement in 9 months. I have 48,300.00 in my current 401k thru my employer and plan on just leaving it alone for several years after retirement because my 2 pensions will support us until social security kicks in. Here’s my question: in 2008 I bought 750 shares of Ford stock…most of that at 2.80 per share…it’s now over 12.00 share, was as high as 14.00. With reinvestment of dividends my 750 shares is now 902 shares….the Ford stock alone makes up about 23% of my portfolio with rest being various mutual funds. I set my 401k up so I could buy stocks/mutual funds outside my company offerings. Should I sell off some of the Ford stock since it alone makes up a quarter of my balance or sit tight? If I should sell some what percentage should I keep?
Thanks for any suggestions you can make!
Jeff Rose says
Hi Darren – There are no hard and fast rules here, but most financial advisors will tell you not to have any more than 5% to 10% of your portfolio in the stock of any one company. I’d lean more toward 5% since Ford is an auto stock, and the auto industry is notoriously cyclical.
Antonio M. says
Hello. I’m 37 and no longer work for the organization that gave me 401k. Since I’m going back to school, can I roll over to IRA and then withdraw tuition costs that way (so that I avoid 10% penalty).
Jeff Rose says
You’ll have to put the money into a rollover IRA account, and that will incur the penalty. The IRS is aware of workarounds, and creates limits to prevent it.
Joseph says
I took out a loan on my 401k in the amount of 20k. It is being paid back thru deductions for the next 2 years. I was advised at the time that this will