IRA and 401(k) withdrawal rules

To encourage retirement saving, the federal government offers special tax breaks for contributing to a qualified retirement plan like an individual retirement account (IRA) or 401(k).

But there’s a tradeoff: If you make a 401(k) withdrawal or IRA withdrawal before you retire, you may have to pay an early withdrawal penalty on top of the ordinary income taxes that will be due upon withdrawal.

Read on to learn more about 401(k) withdrawal rules and traditional IRA withdrawal rules.

Rules for retirement withdrawals on qualified accounts

IRAs and 401(k)s are qualified retirement accounts, which means they receive favorable tax treatment. With traditional IRAs and 401(k)s, pre-tax money grows tax-deferred until you withdraw it in retirement, at which time you pay income taxes at ordinary income tax rates.

Roth IRA withdrawal rules differ from a traditional IRA because your money grows tax-free and you can withdraw it tax-free in retirement. The same withdrawal rules apply to Roth 401(k)s.

For the purposes of 401(k) withdrawals or traditional IRA withdrawals, retirement is considered to be age 59½. If you withdraw from a traditional IRA or 401(k) before this age, those withdrawals are subject to a 10% early withdrawal penalty and taxation at ordinary income tax rates.

Roth withdrawal rules are different. Early withdrawals of Roth IRA or Roth 401(k) contributions are not subject to a 10% penalty, since they were made on an after-tax basis. However, withdrawals of earnings from Roth accounts made before age 59½ and before the account is five years old may be subject to taxes and a 10% penalty.

Note that you must begin taking distributions from traditional IRAs and, in some instances, 401(k)s when you reach age 73. These are referred to as required minimum distributions, or RMDs.

Hardship withdrawals avoid penalties

There are some scenarios in which you could make an early 401(k) withdrawal or IRA withdrawal without paying the 10% penalty. These are known as hardship withdrawals. For 401(k)s, check with your employer about which hardship withdrawals apply to your plan and how to get approved. You may be required to verify that you don’t have any other available financial resources to satisfy your financial need.

Examples of hardship withdrawals for both IRAs and 401(k)s:

• Birth or adoption of a child: Up to $5,000 in penalty-free withdrawals is allowed for each eligible birth or adoption.
• Certain military reservists: This includes military reserve members who are called to active duty for at least 180 days or for an indefinite period.
• Substantially equal periodic payments (SEPPs): Based on one of three available life expectancy formulas, a specific dollar amount is determined for distributions that avoid the 10% penalty when payments begin before age 59½. The distribution amount cannot be modified until the later of the 5th year anniversary of the first SEPP payment and the date you turn 59½. For example, if your SEPP payments begin at age 57, they must continue until age 62. And if you began your SEPP payments at age 51, they would need to continue to age 59½.
• Financial emergencies: The SECURE 2.0 Act added this new exception in 2024 that allows one penalty-free retirement account distribution of up to $1,000 per year to cover emergency expenses. These are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. An emergency distribution of pre-tax deferrals would trigger income taxes but could be repaid by the participant within three years.

Examples of hardship withdrawals for IRA, SEP, SIMPLE IRA and SARSEP plans only:

• Medical expenses: These are defined as qualified medical expenses that exceed 7.5% of adjusted gross income.
• Higher education expenses: These include tuition, fees, and room and board for the next 12 months of postsecondary education for you, your spouse, or your children and dependents.
• Health insurance premiums while unemployed: This exception is available if you have received unemployment compensation payment for 12 consecutive weeks under a federal or state unemployment compensation law.
• First-time home purchase: Up to $10,000 in penalty-free withdrawals is allowed to pay for costs related to the purchase of a qualified principal residence.

See the IRS list of early distribution tax exceptions.

401(k) loan vs. 401(k) withdrawal from your retirement account

When facing financial emergencies or cash flow shortfalls, it can be tempting to withdraw from a qualified retirement plan. However, withdrawing money from a retirement account early and paying penalties and taxes should be done only after you’ve exhausted every other option, since doing so may have a negative impact on your long-term retirement finances.

If you really need to use the money in your retirement account before you’re 59½ and you don’t meet the qualifications for a hardship withdrawal, consider taking out a 401(k) loan instead of taking an early withdrawal.

Many 401(k) plans allow participants to borrow their own money and repay the loan with interest via automatic payroll deductions. You’ll avoid the early withdrawal penalty, retain the tax benefits and keep your retirement plan on track. However, if you leave your job either voluntarily or involuntarily, the loan will become immediately payable (you usually have until your tax filing deadline) or it’s treated as a distribution and is subject to income tax and the 10% early withdrawal penalties.

401(k) loans usually must be fully repaid within five years unless the money is used to purchase a primary residence. The maximum 401(k) loan amount is $50,000 or 50% of the account’s vested value. Not all 401(k) plans permit loans, so ask your plan administrator or review the 401(k) Summary Plan Description to learn more about your plan’s loan provisions.

What is the "Rule of 55?"

Another unique early withdrawal circumstance is known as the Rule of 55. This allows you to withdraw money from your 401(k) penalty-free if you leave your job or are laid off during the year in which you turn 55, or later. Income tax would still be assessed on the money you withdraw, but the 10% early withdrawal penalty would be waived.

The Rule of 55 only applies to the 401(k) plan at your most recent employer and can be a useful tool if you want to retire between the ages of 55 and 59½. Not all 401(k) plans allow for early withdrawals under the Rule of 55, so be sure to check your plan’s Summary Plan Description.

Early retirement withdrawals: Seek advice

It’s critical to understand the rules governing withdrawals from qualified retirement accounts. Otherwise, you could make costly mistakes that jeopardize your retirement financial security. Learn how our approach to financial planning can help you review financial opportunities from all perspectives.