401(k) Withdrawals Made Simple: What Age Can You Go Tax-Free?

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A 401(k) is an employer-sponsored retirement account. Like other tax-advantaged savings accounts, 401(k) accounts offer a way to invest money without paying taxes. However, if you withdraw funds before you reach retirement age, you’ll end up paying hefty penalties. 

See Also: Owe Money to the IRS? Most People Don’t Realize You Can Do This

So, how do retirement account withdrawals work? And at what age is 401(k) withdrawal tax free? Here’s what you need to know.

At What Age Is 401(k) Withdrawal Tax Free?

The minimum age for penalty-free withdrawals from your 401(k) account is 59 ½, and the IRS requires retirees to start making withdrawals by age 73.

There are some caveats to this age restriction. The rule of 55 is a set of guidelines that allows you to make penalty-free withdrawals from your 401(k) early if you leave your job after the age of 55. This enables early retirees to free up some cash before they reach official retirement age. 

A Quick Guide to 401(k) Withdrawals

If you have an employer-sponsored 401(k) account, you probably already know how it works: You set aside a certain amount of your income with each paycheck. Depending on the type of account you have, your employer might match all or part of your contributions. Those contributions are made in pre-tax dollars. You can use these contributions, not only to grow your retirement fund, but as a way to write off taxes or claim deductions to also potentially reduce your taxable income.

But what happens when you need to withdraw those funds? Here is a quick guide to walk you through 401(k) withdrawals. 

A note: 401(k) contributions are made with pre-tax money, but they don’t affect the FICA tax rate, which is used for funding Social Security and Medicare.

Are 401(k) Withdrawals Tax Free?

Because 401(k) contributions aren’t taxed at the time they’re made, you will have to pay federal income taxes on your funds once you withdraw them — regardless of your age. 401(k) distributions are taxed at a mandatory withholding rate of 20%. The amount you owe will depend on your overall income and federal income tax bracket you fall into for the year.

If you make a withdrawal before age 59 ½ — or age 55 with the rule of 55 — you will be taxed an additional 10%. Other federal and state income tax requirements might also apply.

When people refer to “tax-free” withdrawals, they generally mean unpenalized withdrawals that aren’t subject to that extra 10% and additional penalties. 

Can You Withdraw From Your 401(k) Before Retirement?

You can withdraw from your 401(k) at any time and pay the 10% penalty. However, the IRS offers exemptions for certain life circumstances:

• Having a child: When you have or adopt a child, you can withdraw up to $5,000 from your account tax free.
• Buying a home: The IRS allows up to $10,000 in tax-free withdrawals for first-time homebuyers.
• Disaster recovery: If you need financial help after a natural disaster, you can withdraw up to $22,000.
• Medical emergencies: You can withdraw funds from your 401(k) to pay for a medical emergency if the costs are greater than 7.5% of your annual income. 

Before you withdraw funds from your retirement savings account, talk to a tax professional or check online to find out if you can avoid the 10% tax penalty. 

Know how long it will take to get a tax refund can also help you plan your finances better, since you can use your refund toward furthering your retirement savings.

Can You Borrow Money From Your 401(k)?

Some 401(k) plans allow accountholders to borrow from the account for short-term spending. This can help you avoid the tax penalty of an early withdrawal, but your loan will come with interest. Any funds you don’t repay according to your loan terms will be charged as an early withdrawal. 

If you qualify for an exemption, a tax-free withdrawal is generally a less risky choice than a 401(k) loan. 

What if You Roll Your Money Into Another Account?

It is possible to roll your 401(k) savings into another 401(k) or individual retirement account without paying taxes. You’ll still be taxed when you withdraw the funds from the new account, whether in retirement or earlier. 

Many people choose to roll over their 401(k) accounts when they start a new job or decide to switch to a different type of savings account. To avoid tax penalties, you must deposit the funds into the new account within 60 days of your distribution.

Explore Alternative Retirement Savings

An employer-sponsored 401(k) is a smart investment. But it isn’t the only way you can save for retirement. In fact, one of the best ways to set yourself up for long-term success is to diversify your savings — consider other savings plans alongside your 401(k), including IRAs, physical assets, and other investments. Note that when you go to sell some of these investments, they could be subject to capital gains tax, in comparison to the tax-deferred growth of a 401(k). That way, if you need to make an early withdrawal from your 401(k) account, you’re still on track for retirement.

401(k) withdrawals are simpler than you might think. By checking for exemptions or following the rule of 55, you can take funds from your 401(k) without paying additional taxes.

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