IRA and 401(k) Withdrawal Rules and Penalties

Understanding Qualified Distributions

Family discussing retirement planning papers with a financial advisor

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The Internal Revenue Service implements certain rules for when you can and must take early, qualified, or required distributions from a 401(k) retirement plan or an IRA. You can face tax penalties of 10% to 50% if you don't understand and follow these 401(k) withdrawal rules.

Let's look at how these rules vary depending on the type of account.

Understanding Qualified Distributions

Qualified distributions are made tax-free and penalty-free from a qualified retirement plan. This typically means that they're taken after age 59½ or under some extenuating circumstances.

There's no penalty for withdrawing your money after age 59½, but you'll pay ordinary income tax on the distributions if you've invested in a traditional pre-tax 401(k) or a traditional IRA. Roth IRAs and Roth 401(k) contributions are made with taxed dollars, so distributions aren't taxable when you're retired and you've owned the Roth for 5 years or more,

The benefit of tax-deferred investment accounts is that you should be retired when you begin taking distributions from them. Presumably, you'll be in a lower tax bracket at that time because you're no longer collecting a salary.

Early 401(k) Withdrawal Rules

Early withdrawals are those taken from a 401(k) before age 59½. They're taxed as ordinary income, and they're subject to an additional 10% penalty besides. But there are some exemptions from the penalty. They include total and permanent disability, loss of employment when you're at least age 55, and distribution of the account pursuant to a qualified domestic relations order after a divorce. You can also use 401(k) distributions to pay for unreimbursed medical expenses above 7.5% of your modified adjusted gross income (MAGI), or above 10% of your MAGI if you're under age 65.

Not only do you lose a good chunk of your savings to taxes when you make an early withdrawal, but you'll also miss out on the potential future savings growth from the withdrawn amount.

Some 401(k) plans allow for hardship distributions, but they're usually subject to approval by the employer. They must be made to meet an extraordinary, significant, and immediate financial need, and can be no more than the amount required to meet that need.

Borrowing From a 401(k)

A 401(k) loan can be a better option than an early distribution if your employer allows it. There's no credit check and interest rates tend to be lower than with other types of loans, but fees can apply. You must pay yourself back with interest, and you must do so within five years—or almost immediately if you leave your job.

If you take a 401(k) loan, you'll lose one of the main tax benefits of the 401(k) because you're paying yourself back with after-tax money. You'll also miss out on what could be crucial months or years of investment returns. Another major downside of a 401(k) loan is that you might have to pay back the loan within 90 days if you leave your job or are terminated. Your loan balance will be treated as taxable ordinary income if you don't, and you might also be hit with that 10% early withdrawal penalty.

Early IRA Withdrawal Rules

Early withdrawals from traditional IRAs are also subject to ordinary income taxes and the 10% penalty. IRAs have many of the same exceptions to the penalty as 401(k)s, but there are a few differences.

You can withdraw early from an IRA without penalty if you use the money to pay for:

IRAs don't require a qualified domestic relations order to divide benefits after a divorce, but these distributions are nonetheless subject to certain rules.

Roth 401(k) and Roth IRA Withdrawal Rules

Roth IRAs and Roth 401(k)s are funded with after-tax contributions, so withdrawals aren't treated the same as those from regular IRAs and 401(k)s. Distributions are tax-free, provided that:

  • You're at least age 59½.
  • You've held the Roth account for at least five years.

The age rule doesn't apply if the account owner is disabled or dies.

There's still a 10% tax penalty for early distributions, but that's only on investment earnings. You can withdraw the amount of your original contributions tax-free before age 59½ because you've already paid tax on the money you invested. This makes a Roth account a really flexible savings tool. You can use this type of plan to supplement your savings for future non-retirement-related expenses, such as college tuition or an emergency fund.

Required Minimum Distributions

You must begin withdrawing money from your traditional IRA account in the form of required minimum distributions (RMDs) when you reach age 72. The IRS will fine you 50% of the amount you should have taken out if you don't. The must-start age for RMDs was 70½ prior to the passage of the SECURE Act of 2019, and it still is for those who reached age 70½ before Jan. 1, 2020. As of that date, the age is 72 for everyone else.

The IRS uses life expectancy tables to determine how much you must take out each year to avoid the 50% tax. Your 401(k) can remain intact as long as you're still working, and Roth IRA holders don't have to take RMDs until the account owner dies.

The Balance does not provide tax or investment financial services or advice. This information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.