How To Withdraw Money From A 401(k) Early

Making an early withdrawal from your 401(k) might sound like a tempting idea — after all, it is your money. But once you know the ramifications, you may feel differently.

For instance, withdrawing money early from a 401(k) can result in penalties and taxes. You’ll also miss out on potential compounding. Still, some situations may require an early withdrawal as a last resort.

Here’s what you need to know if you’re considering taking an early withdrawal from your 401(k) and some alternatives that may prove to be better options for your financial situation.

3 ways to withdraw from a 401(k) early

1. Take an early withdrawal

An unexpected job loss, illness or other emergencies can wreak havoc on family finances, but taking an early withdrawal from your 401(k) should be a measure of last resort. Tread carefully, as the decision can come at a high cost.

First, not all employers allow early 401(k) withdrawals. You may need to speak with someone at your company’s human resources department to see if this option is available.Unless you’re age 59 ½ or older, your traditional 401(k) withdrawal will be subject to tax at your ordinary income rate (based on your tax bracket) plus a 10 percent penalty. With a Roth 401(k), you can withdraw contributions tax- and penalty-free at any time. But if you withdraw earnings before 59 ½, you’ll owe ordinary income tax and a 10 percent penalty.

Once you’ve owned the Roth 401(k) for at least five years and are at least 59 ½ years old, you can withdraw both contributions and earnings without penalty or tax. However, if you didn’t start contributing to a Roth until age 60, you would not be able to withdraw funds tax-free for five years, even though you are older than 59 ½. (Note the five-year rule does not apply to withdrawing contributions; those are still tax- and penalty-free regardless of the age of the account.)

2. Hardship withdrawals

Some employer plans permit hardship withdrawals from traditional or Roth 401(k) accounts. However, this type of withdrawal permanently reduces your portfolio’s balance, and you’re taxed as noted above.

After making a hardship withdrawal, you typically cannot replace the money you withdrew. Additionally, some companies bar you from contributing to the plan for six months or more.

For those contemplating a hardship withdrawal, remember your 401(k) is meant to provide income in retirement and should not be tapped for other reasons unless your situation is truly dire.

What type of situation qualifies as a hardship?

The following limited number of situations rise to the level of “hardship,” as defined by Congress:

IRS rules state that you can only withdraw what you need to cover your hardship situation, though the total amount requested “may include any amounts necessary to pay federal, state or local income taxes or penalties reasonably anticipated to result from the distribution.”

“A 401(k) plan — even if it allows for hardship withdrawals — can require that the employee exhaust all other financial resources, including the availability of 401(k) loans, before permitting a hardship withdrawal,” says Paul Porretta, a compensation and benefits attorney at Troutman Pepper in New York City.

However, the passage of the SECURE Act 2.0 in late 2022 created new conditions for emergency withdrawals.

Emergency withdrawals allowed by the SECURE Act 2.0

The SECURE Act 2.0 was a sweeping piece of retirement plan legislation signed into law in December 2022. It brought a slate of changes to the laws governing retirement accounts, building on provisions passed in the original 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act.

Specifically, the SECURE Act 2.0 added the ability for employers to offer retirement plans that provide the ability to make emergency withdrawals:

3. 401(k) loan

401(k) loans are generally considered to be a better option than a hardship withdrawal if given the choice. However, not all 401(k) plans allow loans, and there are often rules you must follow to avoid penalties and taxes.

The amount you can borrow depends on your plan, but the IRS limits it to either 50 percent of the vested value of your account or $50,000, whichever is less. There is usually a loan minimum as well. You can find out how much you can borrow by viewing your account online, speaking to a plan representative or contacting your HR department.

Key considerations with 401(k) loans

• Most plans only allow one loan at a time and require it to be paid off before requesting another one.
• Your plan may also require that you obtain consent from your spouse or domestic partner.
• You must make regular payments on the principal and interest, typically through payroll deduction.
• Loans must be repaid within five years unless borrowed for the purchase of a primary residence.
• If you leave your job with an outstanding 401(k) loan, you must repay it within a specific time or face tax and early withdrawal penalties.
• The money you use to pay yourself back is done with after-tax dollars.

Although getting a loan from your 401(k) is relatively quick and easy, the benefit of paying yourself back with interest will likely not make up for the return on investment you could have earned if your funds had remained invested.

Another risk: If your financial situation does not improve and you fail to pay the loan back, it will likely result in penalties and interest.

Impact of a 401(k) loan vs. a hardship withdrawal

Before you decide, consider the financial impact of each. For example, consider this scenario developed by 401(k) plan sponsor Fidelity:

That’s a significant difference simply to access the same $15,000. Also, due to the time value of money and the loss of compounding opportunities, taking out $23,810 now could result in tens of thousands less at retirement, maybe even hundreds of thousands, depending on how long you could let the money compound.

Alternatives to taking a hardship withdrawal or loan from your 401(k)

Before you decide to take money out of your 401(k) plan, consider the following alternatives:

• Temporarily stop contributing to your employer’s 401(k) to free up some additional cash each pay period.
• Transfer higher interest rate credit card balances to a lower rate card to free up some cash.
• Take out a home equity line of credit, home equity loan or personal loan.
• Borrow from your whole life or universal life insurance policy.
• Consider taking on a second job or tapping into family or community resources, such as a non-profit credit counseling service.
• Downsize to reduce expenses, get a roommate and/or sell unneeded items.

Can you make an early withdrawal from a 401(k) without penalty and for what reasons?

If any of these apply to you, you can likely access your money early without having to pay the penalty, though you won’t get out of paying taxes on the distribution:

— Bob Haegele contributed to an update of this article.