How to Make Withdrawals From Your 401(k)

Regardless of when you do it, making a withdrawal from your 401(k) requires you to follow a handful of rules. That’s because you’re tapping your tax-deferred retirement savings, which means the IRS keeps a close eye on it. During retirement, these withdrawals are also known as distributions. Perhaps the most important age when it comes to 401(k) withdrawals is 59 ½. That’s because withdrawals made before that age may come with a steep 10% penalty.

For more hands-on guidance, consider enlisting the help of a financial advisor.

Rules About Regular 401(k) Withdrawals

401(k) plans are tax-advantaged accounts that are designed to help people save for retirement. You don’t owe taxes on your contributions, your company’s matches or any investment earnings until you retire. Once you officially retire, you’ll pay ordinary income taxes on your withdrawals. So whatever tax brackets you fall into as a retiree will determine your taxes.

Generally, you’re eligible to start taking distributions from your 401(k) when you reach 59 ½ years old. You can also take distributions if you lose your job at age 55 and decide to retire. These are the earliest ages at which you can start receiving monthly or annual installments that draw down your account, at least without penalty.

On the other end, the latest point you can start withdrawing is April 1 of the year after you turn 73. However, this only applies to anyone who turned 72 after Dec. 31, 2022. Everyone who reached 72 before then had to take their first RMD by April 1, 2023.

The IRS not only requires that you start taking out money from your 401(k), it specifies how much. This amount is called a required minimum distribution, or RMD. It’s the minimum amount you must withdraw, based on your life expectancy.

Do you need help figuring out your required minimum distributions? Try SmartAsset’s RMD calculator to learn more.

Rules About Early 401(k) Withdrawals

Should you make a 401(k) withdrawal before you reach age 59 ½, the IRS may consider it an early distribution. This will induce a 10% tax penalty on it. In addition, because you have yet to pay any taxes on the money, you’ll owe income taxes. As you can imagine, this is a pretty dangerous way to withdraw funds from your 401(k).

That said, the IRS allows for penalty-free hardship withdrawals. To qualify for one, you’ll need to demonstrate what the IRS calls an “immediate and heavy need.” On top of this, you must prove that there are no other assets that could satisfy that need, such as a vacation home.

Examples of hardships that can earn you an exemption from the 10% withdrawal penalty include:

Disability
Death
Funeral expenses
Qualified medical expenses
Purchase of a home
Education expenses
Housing payments needed to prevent eviction
Certain home repair expenses for a primary residence

It should be noted, though, that it’s up to your plan to allow for hardship withdrawals. The IRS doesn’t require them. It only delineates the circumstances under which they may happen. Also, you should know that though you won’t have to pay the 10% penalty, you will still have to pay income taxes on the distribution.

Rules About 401(k) Required Minimum Distributions (RMDs)

Again, the minimum age for RMDs changed in recent years. Before, you had to start taking them either when you retired or when you turned 70 ½. However, this age requirement still holds for anyone who turned 70 ½ in 2019 or earlier. The RMD age was temporarily moved back to 72, but has since been increased to 73.

April 1 of the year that follows the year you reach your RMD is your starting date for RMDs. The deadline to take all subsequent RMDs then shifts to December 31. So your second year and thereafter, you must take your RMD by December 31.

If you wait until April 1 of your starting year to take your RMD, you will have to take two years’ worth of RMDs in the same year. You may want to avoid this, as it will increase your income for that year, likely putting you in a higher tax bracket. If you fail to take any RMD or you don’t take a large enough RMD as required by the IRS, you may have to pay a 25% penalty on the money you should have withdrawn. That penalty could be reduced to just 10% if you the RMD is corrected within two years.

Rules About 401(k) Loans

Another option open to employers is to allow 401(k) plan participants to borrow from their 401(k) accounts. You then repay the loan plus interest. Some plans recommend covering the interest by bumping up the pre-tax deferrals from your paycheck.

The good news about 401(k) loans is that they offer lower interest rates and don’t require a credit check, unlike many other loans. The bad news is that if you leave your company voluntarily or involuntarily, the loan becomes due typically by the time your taxes are due for that year. If you can’t repay the funds you’ve borrowed within that time frame, the IRS treats the money as income, taxes it as such and levies the 10% early withdrawal penalty.

While 401(k) loans that you repay on time don’t come with the 10% IRS penalty, they do come with interest. Also, many companies won’t allow you to contribute to your 401(k) while the loan is outstanding. Because of this, you lose the chance to contribute and take advantage of compound interest.

Bottom Line

A 401(k) helps your retirement savings grow by acting as a tax shelter. When you take early withdrawals before age 59 ½, the tax deference on that money disappears. You’ll also get a 10% penalty on your bill. On the other side of 59 ½, you must begin to take distributions by age 73 (or 72 depending on when you turned 72), if you haven’t already begun. The penalty for not doing so is a whopping 25% of the money that should have been withdrawn.

Tips for Planning Your Retirement

Switching from saving for retirement to spending your nest egg is a tough transition. A financial advisor can help you figure out which accounts to draw down first, when to start taking Social Security and more. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If the idea of a protected stream of income that you can’t outlive sounds good, you may want to look into buying an annuity. These insurance products are pretty complex though, and there’s a wide variety and selection. In other words, you’ll want to do your homework. You can start by reading up on the pros and cons of annuities.