Your Guide to Taking Money Out of a 401(k)

What you need to know to avoid costly mistakes

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© The Balance, 2018

In an ideal world, everybody would leave their 401(k) funds alone until they need the money for retirement. That might mean rolling your account over to an Individual Retirement Account (IRA), but it also means not cashing out the funds prior to reaching retirement age, to allow the money to grow to its maximum potential amount. In investing, time truly is your best asset. At some point though, you will begin taking distributions, and here's what you need to know.

The best way to take money out of your 401(k) plan depends on three things:

  1. Your age
  2. Whether you still work for the company that sponsors your 401(k) plan
  3. Your 401(k) plan’s rules

Key Takeaways

  • A 10% tax penalty will apply if you take a withdrawal from your 401(k) before age 59 1/2, and you’re no longer working for your employer.
  • You can take a penalty-free 401(k) withdrawal if you're over a certain age, usually 59 1/2, and you no longer work for your employer.
  • You’ll avoid taxes and penalties if you roll your 401(k) over into an IRA, but it must be a direct transfer, so you won't have access to the cash.
  • Check with your plan administrator to find out whether taking a 401(k) loan instead of a withdrawal is possible.

Taking Money out of a 401(k) Once You Leave Your Job

If you no longer work for the company that sponsored your 401(k) plan, first contact your 401(k) plan administrator or call the number on your 401(k) plan statement. Ask them how to take money out of the plan.

Since you no longer work there, you cannot borrow your money in the form of a 401(k) loan or take a hardship withdrawal. You must either take a distribution or roll your 401(k) over to an IRA.

Any money you take out of your 401(k) plan will fall into one of the following three categories, each with different tax rules.

Regular 401(k) Withdrawal

This applies if you no longer work for the employer that sponsored the 401(k) plan, and you are over age 59 1/2, (​in some cases you only need to be over age 55, as long as you were 55 or older at the point you retired from that employer). With a regular 401(k) withdrawal, you will pay income tax on the amount you take out, but no penalty will apply because of your age.

Early 401(k) Distribution

This applies if you are not yet age 59 1/2 or don’t qualify for the age 55 regular withdrawal, and you're no longer working for the employer that sponsored the 401(k) plan.

You will pay income taxes and a 10% penalty when you take money out of your 401(k) plan as an early distribution. If you need to cash out your 401(k) plan early due to debt or other financial hardship issues, think twice, because your 401(k) assets are protected from creditors, even in Chapter 7 bankruptcy.

401(k) Rollover to IRA

You can do a rollover of your 401(k) account balance to an IRA at a company of your choice. You pay no taxes if you do a rollover to an IRA, and your money can stay in your IRA for your later use. Then you can withdraw money from your IRA only as you need it. You only pay taxes on the amount you withdraw each year. With the IRA, you will also have the option of using a special rule called 72(t) payments which allow you to take money out, and also avoid the early-withdrawal penalty. There are also exceptions to the penalty, depending on your status and how you plan to use your withdrawn funds.

Taking Cash out When You Are Still Employed

Some 401(k) plans do not allow you to take money out of the plan while you still work for your employer. Other plans offer a few choices, such as a 401(k) loan, hardship withdrawal, or in-service distribution.

401(k) Loan

Many 401(k) plans allow you to take money out of the plan through a 401(k) loan in which you borrow against your account balance. The maximum amount of the loan allowed is usually the lesser of $50,000 or half of your vested 401(k) account balance. You will be charged interest, and while the money is out of the account, it's not earning interest so, use this option only in emergencies.

401(k) Hardship Withdrawal

Some, but not all, 401(k) plans allow you to take a hardship withdrawal if your circumstances qualify under the hardship provisions.

In-Service Distribution

A few 401(k) plans allow you to take money out of the plan while you are still employed, by using this option.

In all of the above cases, check with your 401(k) plan administrator or call the number on your 401(k) plan statement to see if they allow these options.

What if You Are the Beneficiary of a 401(k) Plan?

If you are the beneficiary of a 401(k) plan, you'll have a little bit different set of rules that apply to taking money out of the 401(k) plan. Your choices will depend on whether you were the spouse of the 401(k) plan participant or a non-spouse, and whether the 401(k) plan participant had reached age 70 1/2—the age for required minimum distributions (RMD).

If you or your spouse turned 70 1/2 before January 1, 2020, the age for RMDs is still 70 1/2. If you or your spouse turned 70 1/2 on or after January 1, 2020, the age for RMDs is 72.

The Bottom Line

Taking money out of a 401(k) plan means that you'll be dipping into money that is being saved and invested for your future retirement. Consider your other options for additional cash, such as your emergency fund, a personal loan, or a home equity loan. Consider working with a financial advisor to best understand how taking money out of your 401(k) will impact the rest of your finances.