401(k) Early Withdrawal Penalty: What You Need To Know

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Withdrawing your 401(k) early may offer a way out of a tricky financial situation, but early withdrawals also come with consequences.

Key Takeaways

• There is a 10% early withdrawal penalty for withdrawing from your 401(k) before age 59 ½ — plus income taxes.
• The IRS withholds 20% of your early withdrawal, reducing how much you can receive.
• Borrowing from your 401(k) is one alternative. You don’t have to pay taxes or penalties, but you must repay the loan within five years.
• Some exceptions, such as certain medical costs, disability or adoption, may offer penalty-free withdrawal options.
• Early withdrawals still cost money. If you take out $10,000 now, that could cost $30,000 over 20 years in growth.

What Is the 401(k) Early Withdrawal Penalty?

If you withdraw money from your 401(k) before you reach age 59 ½, you’ll pay a 10% early withdrawal penalty. You may also face other penalties depending on your gross income. You might qualify for exceptions to the additional tax. For most financial situations, however, you can find better alternatives than cashing out your 401(k).

Standard Penalty for Early Withdrawals

To discourage early withdrawals, the IRS imposes a 10% penalty on any funds withdrawn from your 401(k) before you reach age 59 ½. If you withdraw $10,000 from your 401(k), you’ll pay $1,000 in taxes on that money.

Additional Tax Implications

A 10% penalty isn’t the only added cost to an early 401(k) withdrawal. Withdrawals are taxed as ordinary income. If you are on the edge of the tax brackets, that money could dramatically increase your marginal tax rate.

Tax Bracket Shift

For example, if your adjusted gross income or taxable income is $48,000 as a single filer, withdrawing even $500 from your 401(k) bumps you from the 12% tax bracket up to 22%. It’s likely that if you need to withdraw from your 401(k), you’ll need more than $500.

Single filers in the middle class earning between $48,476 and $103,350 will only face a 2% jump if an early 401(k) withdrawal bumps them to the next tax bracket. Those earning $197,300 pay an extra 8% — from 24% to 32% — in April if they change tax brackets.

IRS Withholds 20%

The IRS may withhold 20% of your 401(k) to cover these additional taxes, plus the 10% penalty. It’s wise to factor these withholding taxes into the total amount you need to withdraw.  

For instance, if you have credit card debt of $10,000 that you want to pay off using your 401(k), borrowing $13,000 will leave you with $10,400 after the IRS withholds 20%.

If the IRS withheld too much based on your AGI and final tax liability, you’ll get a refund of that money. If it’s not enough, you’ll face a larger tax bill than you expected.

Of course, there are strategies you can use to reduce your tax liability, but these may require help from a tax professional.

How Does a 401(k) Work?

A 401(k) is an employer-sponsored retirement account where funds are pulled from pre-tax dollars. As a result, distributions are considered taxable income when withdrawn. Employers can contribute to a worker’s 401(k), making it an effective and efficient way to ramp up retirement savings.

Employees can access 401(k) funds in advance of retirement, but there may be penalties for cashing out 401(k) early.

Did You Know?

There are exceptions to the 10% penalty. It’s also important to remember the lost opportunity cost of compounding interest if you cash in your 401(k) early.

Common Reasons People Withdraw from Their 401(k) Early

Cashing out a 401(k) is typically not the first financial solution most people consider. When it’s dire and you have no other options, the advantages may outweigh the drawbacks. People usually cash out their 401(k)s for big-ticket, necessary expenses.

These might include:

• Medical or veterinary bills
• Emergency home repairs, such as a new roof or fixing water damage
• Pay off high-interest debt
• Buying a home

People might withdraw from their 401(k) to pay down high-interest debt if the ongoing finance charges and damage to their credit score cost more in the long run than the taxes owed due to withdrawing their 401(k) early.

Exceptions to the 401(k) Early Withdrawal Penalty

People may be able to avoid the 401(k) early withdrawal penalty if they meet certain conditions, according to the IRS.

Hardship Withdrawals

The IRS allows you to make hardship withdrawals from your 401(k) without the 10% early withdrawal tax penalty. Keep in mind that you may still owe taxes, as the money counts as taxable income and increases your AGI.

If you have unreimbursed medical expenses greater than 7.5% of your AGI, you can withdraw from your 401(k) to pay those bills without penalty.

The IRS also allows people to withdraw up to $1,000 or the vested account balance over $ 1,000–whichever is smaller–for emergency expenses.

Similarly, new parents are allowed penalty-free distributions of up to $5,000 per child for qualified birth or adoption expenses.

Under the CARES Act, the IRS allowed people to withdraw from their 401(k) under certain circumstances to cover expenses related to buying a home, including the down payment and closing costs. However, according to the IRS, 401(k) exceptions no longer apply to homebuyers or for higher education costs, as of December 2024.

If you sustained an economic loss in a federal disaster area, you can withdraw up to $22,000 without penalty. This money can help fund home repairs, temporary housing or other expenses related to your loss.

Rule of 55

The rule of 55 allows penalty-free withdrawals for individuals who leave their jobs after age 55.

Disability or Death

You can make penalty-free IRS withdrawals if you have been declared permanently disabled. If the 401(k) owner dies, the spouse or beneficiary may also make penalty-free withdrawals.

Qualified Domestic Relations Orders

In a divorce settlement, an alternate payee can take penalty-free distributions under a Qualified Domestic Relations Order, or QDRO. In the case of domestic violence or abuse, the victim can take up to $10,000 or 50% of the 401(k) account, whichever is less, as penalty-free distributions.

How To Avoid the 401(k) Early Withdrawal Penalty

For taxpayers who don’t meet these requirements for penalty-free withdrawals, there are other ways to tap into your 401(k):

Use Loans Instead of Withdrawals

Instead of taking money out of your 401(k) and potentially having to pay penalties, you can borrow up to $50,000 from that retirement account. You pay the money back into your account, typically at a low interest rate. There is usually no credit check required.

However, if you lose your job, you might have to pay the money back before the loan term ends. Terms are typically five years.

Alternatives to Withdrawing from Your 401(k)

While many people borrow against their 401(k) to pay down high-interest credit card debt, buy a home, or cover emergency expenses, there may be other options that won’t put your retirement savings at stake.

Ideally, you will have another, easily accessible emergency savings account to use.

If you have good credit, you may qualify for a low-interest personal loan. If you are facing debt and your credit score is not good to excellent, consider a debt consolidation loan as an alternative to borrowing against your 401(k).

Consider IRA Rollover Strategies

When you roll over your money from a 401(k) into an IRA, you maintain the tax-deferred growth of that money. If you have a short-term need for cash and will be able to replace the money within 60 days, you can initiate a 60-day rollover. This way, you can access the funds as long as you deposit them into an IRA within 60 days. You don’t have to include that money as gross income, although the IRS does withhold taxes from the distribution.

The True Cost of a 401(k) Withdrawal

In addition to the 10% penalty, a 401(k) withdrawal costs even more, depending on your tax bracket. If you withdraw $10,000, the IRS will withhold 20%, or about $2,000, for taxes, and 10%, or $1,000, of that will go toward your penalty. You will also pay taxes on the loan based on your marginal tax rate. If you are in the 22% tax bracket, you’d owe an additional 2% on top of the IRS withholding taxes. You’d ultimately pay $2,200 to withdraw $10,000.

Additionally, a 401(k) typically grows at a rate of 5% to 8% per year. If you kept $10,000 in your 401(k) for another 20 years, at an interest rate of 7%, it would grow to more than $38,696. So, that $10,000 would ultimately cost you nearly $30,000 between taxes, penalties, and lost returns.

When Early Withdrawal May Be Necessary

For the vast majority of Americans, there are better options than facing a 401(k) withdrawal penalty. It’s smart to speak to a tax accountant or financial advisor before you make a decision that could affect your retirement as well as your annual taxes.

While the IRS offers many exemptions for hardships, other circumstances may not qualify. Hardship exceptions do not include job loss, medical bills under 7.5% of your AGI, credit card debt or other dire financial situations.

If you don’t foresee a way to pay a 401(k) loan on time, withdrawing from your 401(k) early might be one way to avoid digging a deeper financial hole.

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