In general, you can only withdraw money from your 401(k) once you have reached the age of 59½. If you withdraw money earlier, you’re likely to be subject to a 10% early withdrawal penalty.
Use this free calculator to determine the impact of a 401(k) early withdrawal.
Should You Withdraw Early From your 401(k)?
Wondering whether cashing out your 401(k) early is the right answer? Here are a few benefits and drawbacks to consider before making your decision:
Pros:
No repayment required: A 401(k) early withdrawal can be an alternative to a 401(k) loan or another type of financing like a personal loan or home equity loan. The benefit of a 401(k) early withdrawal is that, unlike other types of financing, you won’t have to pay it back.
Helpful in financial emergencies: In a perfect world, no one would have to withdraw from their 401(k) early. But it can be a helpful last resort for those in a financial emergency with limited other options.
Cons:
Income taxes: When you take money from a traditional 401(k), you have to pay income taxes on those withdrawals. These taxes apply whether you withdraw the money early or during retirement. But if you’re withdrawing money to cover a financial emergency, taxes will reduce the amount that’s actually available to you to spend.
Penalty: When you take an early withdrawal from your 401(k), you’ll be subject to a 10% early withdrawal tax penalty, except in select circumstances. We’ll cover this in more detail below.
Diminished future earnings: The income tax and penalty you’ll pay on your early withdrawal aren’t the only losses. By reducing your 401(k) balance, you’re also reducing your potential earnings and, as a result, will have less money available to you during retirement.
401(k) Early Withdrawal Alternatives
If you really need money and tapping your retirement savings is the only way to get it, there are a couple of alternatives to an early withdrawal from your 401(k) plan.
401(k) loan
The IRS allows individuals to withdraw up to $50,000 or 50% of their 401(k) balance, whichever is lower. 401(k) loans generally must be repaid within five years or as soon as the individual leaves the company that sponsors the plan. The benefit of using a loan instead of an early withdrawal is that as long as you repay it within the specified time, the amount isn’t subject to income taxes or the 10% early withdrawal penalty.
401(k) hardship withdrawal
Individuals facing financial hardship can take money from their 401(k) balance to cover it without paying the normal 10% penalty. To qualify for a hardship withdrawal, you must have an immediate and heavy financial need and may only withdraw as much money as is required to satisfy the financial need. While the money won’t be subject to the 10% penalty, you’ll still pay income taxes on it.
Roth IRA withdrawal
Because you’ve already paid taxes on your Roth IRA contributions, the IRS allows you to withdraw them without additional penalties. The catch is that the money must be in your IRA for at least five years before you can withdraw it. You can also only withdraw your original contributions, not the earnings.
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
