401K BASIC WITHDRAWAL RULES
- You must be at least at least 59½ years old to start taking distributions without a 10% penalty.
- To withdraw from a Roth 401k, you must be at least 59½ years old and your Roth 401k account must be at least 5 years old.
- Early withdrawals are subject to a 10% penalty, plus income taxes.
- Qualified distributions from a traditional 401k get taxed as regular income. Qualified distributions from a Roth 401k are tax-free.
- Your employee contributions are always 100% vested and are always available for withdrawals. Employer match contributions must be vested before they can be withdrawn. Depending on the company, vesting may require one to two years of service.
- A 401k has required minimum distributions (RMD). At the age of 73, you’re required to start taking distributions each year, until your account is emptied.
Retirement plans, like the 401k, have an eligible age for making qualified withdrawals. If you take money out of your account before you reach the eligible age, you’ll have to pay penalties and taxes.
When can you withdraw from a 401k?
The eligible age for withdrawing from a 401k is 59½. Earlier withdrawals are hit with a 10% early withdrawal penalty, plus income taxes on the amount drawn.
For example, if you make an early withdrawal of $10,000 from your account, you’ll have to pay 10% of that ($1,000) to the IRS and pay state and federal income taxes on the $10,000 withdrawn. The amount in taxes you’ll need to pay depend on your tax bracket and tax rates at the time of withdrawal.
If you have a Roth 401k, there’s one additional withdrawal rule: Your first contribution must be at least 5 years ago. Even if you’re over the age of 59½, you cannot take a qualified distribution without penalties if your account is under 5 years old. This rule is commonly referred to as the 5 Year Rule; all Roth retirement accounts, like a Roth IRA, follow this rule.
Also read: Roth 401k Withdrawal Rules
Required minimum distributions (RMD)
You’re not obligated to withdraw any money when you turn 59½. This is just the age where you can start withdrawing without any penalties. You don’t have to start taking distributions until your RMD kicks in at the age of 73.
A 401k has required minimum distributions. You must start taking distributions from your account every year once you turn 73 years old. If you don’t, you’ll be taxed 50% of the amount you were supposed to withdraw. You can refer to the RMD table to calculate your RMD amount.
Employer contributions must be vested
Some employers offer employer matching contributions and match your contributions up to a specified percentage of your salary each year. For example, your company may offer dollar-for-dollar employer matching up to 5% of your salary. If you make $100,000 per year, your employer will match your contributions up to $5,000 (5% of your salary).
Employee contributions are always 100% vested, meaning you own and control the money you contributed. Some employers will place a vesting period, where you’ll have to work for a period of time before employer contributions get vested. For some companies, vesting is immediate; for others, vesting can take place after one or two years of service.
In order to withdraw money contributed by your employer, the vesting period set by your company must have passed.
Also read: What is the Average 401k Employer Match?
Do you have to pay taxes on withdrawals?
Whether you pay taxes on withdrawals for a 401k depends on if you’re withdrawing from a traditional 401k or Roth 401k.
- If you’re taking qualified distributions from a traditional 401k, it’ll be taxed as regular income since you deferred your taxes when you contributed.
- If you’re taking qualified distributions from a Roth 401k, you won’t have to pay any taxes since you already paid income taxes when you contributed.
A traditional 401k is funded with pre-tax dollars. You get a tax deduction at the time of contribution, reducing your income tax. However, withdrawals in retirement get taxed as regular income. A Roth IRA is funded with after-tax dollars. You don’t get a tax deduction when you contribute, but your withdrawals in retirement are tax-free.
Exceptions to the early withdrawal 10% penalty
There are certain instances where the IRS will let you make early withdrawals, before the age of 59½, without paying the 10% penalty.
- You become disabled or pass away.
- Money for funeral expenses.
- Unreimbursed medical bills
- Health insurance premiums (if you were unemployed for at least 12 weeks).
- Higher education expenses for yourself, spouse, children, grandchildren, or immediate family members.
- For buying your first home, you can take out a maximum of $10,000.
- Money needed to prevent eviction or foreclosure.
You may also be able to make early withdrawals without penalties if you stop working for the company sponsoring your 401k after reaching the age of 55.
Also read: How to Fix Overcontributions to a 401k
An alternative option to withdrawing early from your 401k is to take out a 401k loan, if your company’s plan provider allows it. Not all 401k plans are set up to offer loans, but if they are, the IRS lets you borrow up to 50% of your account’s value up to a maximum of $50,000. You’re given 5 years to repay the loan, or if you use the money for purchasing a primary residence, you’re given up to 15 years for repayment. Interest rates are usually Prime Rate plus one or two percent.
A 401k loan works the same way as a solo 401k loan, and is a better option than withdrawing money and paying the 10% penalty fee, but keep in mind that you’re still disrupting your tax-free compounding and depleting your account of funds that would otherwise be invested.
Advantages of a 401k loan
- There’s no credit check and nothing appears on your credit report.
- You can use the money however you like.
- Interest rates are typically lower than other loan options.
- Late and missed payments do not affect your credit score.
Disadvantages of a 401k loan
- You’re depleting your retirement account of funds that would otherwise be invested and earning you compound interest.
- If you leave your employer or get terminated, you’ll have to repay the loan sooner (by the tax filing date the year after taking out a loan).
- Failure to repay the loan by the due date could result in penalties and an assessment by the IRS.
- You cannot make any additional contributions to your 401k until your loan is paid off.
Can I withdraw everything at once when I retire?
Yes, you’re free to take as much money as you want out of your 401k, whether it’s an early withdrawal or a qualified withdrawal in retirement.
With a Roth 401k, you don’t need to think about taxes since withdrawals in retirement are tax-free.
With a traditional 401k, any withdrawals made from your account are taxed as regular income. As a result, withdrawals need to be planned more carefully with a traditional 401k than a Roth 401k. The amount in taxes that you’ll have to pay depend on your tax bracket and tax rates at the time of withdrawal. It may be more advantageous to withdraw amounts calculated by how much taxes you’ll owe each year.