401(k)s have different rules on when a participant can access their retirement savings without paying an early withdrawal penalty. Younger participants have fewer opportunities to take out money from their 401(k)s compared to their older colleagues who are already retired or approaching retirement age. The money in a 401(k) is intended to fund retirement, and the government enforces different rules to discourage withdrawals before attaining retirement age.
The IRS requires that a 401(k) participant must be at least 59 ½ to begin taking money out of a 401(k) penalty-free. If you want to start taking distributions before age 59 ½, you will pay income tax and a 10% early withdrawal penalty tax on the amount you take out of your 401(k). An exemption to this requirement is when an employee quits or is fired by the employer at age 55. This exception is known as the rule of 55, and it allows employees who leave the employer at 55 to withdraw their retirement savings without paying a penalty.
Withdrawing Funds from a 401(k) Before 55
If you are younger than 55, you may still qualify to withdraw money without quitting your current job. You can take a hardship withdrawal if you have a qualified expense. For example, you can take a hardship withdrawal to pay qualified educational fees, medical expenses, alimony and child support, repair of damage to your residence or to purchase your principal residence. You will owe income tax on the amount you take out from your retirement savings as a hardship withdrawal.
Withdrawing Funds from a 401(k) at 55
The rule of 55 allows 401(k) participants to withdraw money from the retirement plan penalty-free at age 55. The IRS requires that an employee must have left their employer, either by being laid off, fired, or simply quitting, in the calendar year they turn 55 to get a penalty-free distribution. If you lost your job at 54, you do not qualify to withdraw money tax-free from the 401(k) when you attain age 55.
The Rule of 55 does not apply to the old 401(k)s left with former employers; it only applies to the current 401(k) with your current employer. If you still have money in the old 401(k)s of a former employer, and you were not yet 55 when you left, the rule of 55 does not apply. You will have to wait until you are 59 ½ to start taking withdrawals from the old 401(k)s without paying a penalty tax. Still, you can roll over the old 401(k)s into your current 401(k) before you are 55 so that you can take a distribution penalty-free.
Withdrawing Funds from 401(k) after 55 But Before 59 ½
If you are 55 or older (but not yet 59 ½) and still working for the company managing your retirement savings, you cannot take a penalty-free distribution until you are 59 ½. However, you may still qualify to take a hardship withdrawal if you have a qualified expense. You will owe income taxes and a 10% penalty tax on the distribution you take. You may also qualify for a 401(k) loan if your retirement plan provides this benefit.
Withdrawing Funds from 401(k) after 59 ½
As soon as you turn 59 ½, you are allowed to access your retirement savings in your 401(k) plan without any issue. Here are the two scenarios when you can access your money at age 59 ½:
Still working
If you are still working at your employer’s company, you may not have access to retirement savings even if you have attained age 59 ½. However, you should check with your employer to see if it allows in-service distributions to 401(k) participants who have attained 59 ½. If you have old 401(k) accounts left with former employers, you may be able to cash out after you’ve attained 59 ½.
Retired
If you left employment after 55 years and you are already retired, you may access your 401(k) money at age 59 ½ without paying a penalty tax on the withdrawal. If you had rolled over your 401(k) to an IRA, you also have to wait until you are 59 ½ to take out of money out of your IRA account tax-free.
However, just because you are 59 ½ does not mean that you have to cash out your retirement savings. You can defer taking money out of your retirement plan until you are 72 when you can start taking the required minimum distribution. This allows the money to continue growing tax-free so that you will have enough money to live on in retirement.
Withdrawing Funds from 401(k) at 72
If you are age 72, you must start taking annual distributions from the 401(k), commonly known as required minimum distributions (RMD). You must take the first distribution by April 1 of the year you turn 72, and thereafter, you will be required to take the annual withdrawals by December 31 each year. If you delay in taking the first distribution, you must take two distributions in the same year, which will push you to a higher tax bracket. If you miss taking a mandatory distribution, the IRS imposes a 50% penalty on the amount you were required to take during the specific period.
An exemption to the RMDs is if you are still working. To qualify for this exception, you must not own 50% or more of the employer’s company. You can use this exception to delay taking the mandatory distributions until when you stop working.
Alternatives to Withdrawing Money from a 401(k)
If you are not yet 59 ½ and you need money in the short term, you can consider other sources of funds from your 401(k) to avoid losing the tax-advantaged growth of your 401(k). Here are the two alternatives to consider:
401(k) loan
The IRS allows 401(k) participants to borrow against their retirement savings as long as the employer allows it. Check with your plan administrator to know if this option is available. If your employer allows 401(k) loans, it will generally set the terms of the loan i.e. interest rate, loan installments, and loan term.
You can borrow as much as 50% of your vested 401(k) balance up to a maximum of $50,000. You will have up to 5 years to repay the loan, and the interest you pay on the loan is deposited back to your 401(k) account. However, if you are using the 401(k) loan to purchase your primary residence, the employer can allow as much as 15 years to repay the loan. There are no credit checks involved when you take a 401(k) loan, and the loan will not appear on your credit report.
IRA Rollover Loan
Another way to “borrow” from your retirement savings is to roll over 401(k) into an IRA. You can opt for an indirect rollover where the plan administrator sends you a check with your 401(k) balance, and you must deposit the funds into the IRA within 60 days. During the 60 days, you can use the funds to meet your short-term needs and have it safely deposited in an IRA before this period lapses. In the event you are unable to deposit the funds in an IRA within the required period, the IRS will consider this an early distribution and you will owe federal taxes on the money.
