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By Stang Gappa
Updated on June 6, 2024
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Everyone seems to suggest that saving in your 401(k) is a great idea, and they’re not wrong about that. But when do you actually get to use the money? This is an important question with a complex answer.
Here, we’ll detail the age at which you can withdraw from your 401(k), exceptions to this rule, and different variations of how withdrawals can ultimately play out. Finally, we’ll explore some alternatives to 401(k) withdrawal.
The simple answer to this question is age 59.5. Once you’ve made it to 59.5, you have penalty-free access to your 401(k) money. But that doesn’t mean there aren’t other factors that might influence your withdrawal decision.
While you’ll avoid the infamous 10% penalty for early withdrawal if you take from your 401(k) at 59.5, you’ll still be subject to ordinary income tax (your highest rate) on every dollar you withdraw.
Assuming you’re in the 24% tax bracket for Federal taxes and the 5% bracket for State taxes, a $10,000 withdrawal from your pre-tax 401(k) will cost $3,100 in total tax.
Note: the above example refers to a withdrawal from a pre-tax, traditional 401(k). You likely won’t be liable for taxes upon withdrawal if you have a Roth 401(k).
Let’s be clear: you can withdraw any amount from your 401(k) at any time, but you will be penalized and taxed in different ways depending on how old you are at the time of withdrawal and how you use the money. Taking money from your 401(k) before retirement is usually not a great financial planning move – but there are instances where you might find it necessary to do so.
Withdrawals from your 401(k) before age 55 will typically be subject to a 10% penalty, in addition to income taxes (assuming we’re working with a pre-tax, traditional 401(k)).
Withdrawals before age 55 are fairly costly: not only will you have to pay a penalty and taxes, but you’ll also lose the potential tax-deferred growth of the money you withdrew.
Needless to say, a withdrawal before age 55 is discouraged. However, there are a number of IRS-prescribed exceptions to the 10% penalty rule. These withdrawals will still be subject to income tax, but you might be off the hook for the 10% penalty in the following situations:
Other situations, sometimes termed “hardship withdrawals”, allow for a 401(k) plan participant to withdraw from their 401(k) early. These are meant for people who have an immediate and heavy financial need:
Note that these are only a few scenarios where you may not need to pay the 10% penalty – but in many cases, you may still be hit with it A complete list of exceptions to the 10% penalty can be found here.
Also note that even if you claim a hardship withdrawal, you may still have to pay the 10% penalty depending on what you used the money for, and if your withdrawal was limited to the amount you actually needed.
If this isn’t complicated enough, the IRS has another set of rules for IRA distributions that are similar to, but not the same as, those for 401(k) distributions. All in all, it’s a great idea to avoid the early withdrawal penalty when possible, and use your retirement accounts exactly as they’re intended: for retirement.
One of the benefits of holding retirement money in a 401(k) – as opposed to an IRA or other vehicle – is that you have the option to retire (somewhat) early and access your money penalty free via the Rule of 55.
According to the Rule of 55, a retired worker aged at least 55 may access their money from qualified retirement plans (like a 401(k)) without an assessed penalty. The key here is that you have to be retired (or at least separated from your employer) to be able to take advantage of the exception. Importantly, you will still owe income tax on any withdrawals.
One important wrinkle to the Rule of 55 is that it only applies to your most recent 401(k), or the one sponsored by the employer you most recently separated from. The Rule of 55 also applies to 403(b)s, which are the non-profit world’s 401(k) plans.
As an alternative, you have the option of taking advantage of Rule 72(t), which allows a separated worker to effectively annuitize their 401(k) by taking substantially equal periodic payments from their retirement plan. This may be harder to accomplish than the Rule of 55, since Rule 72(t) requires at least five consecutive annual withdrawals to be considered valid.
However, Rule 72(t) can be applied at any age, but the Rule of 55 is only applicable after your 55th birthday. Withdrawing before the age of 59.5 is generally considered an early distribution.
Overall, it is possible to access your 401(k) money penalty-free between age 55 and 59.5, but you will need to adhere to specific legal requirements. You may not be ready or able to retire at 55, so be judicious when it comes to taking money out of your retirement plan. You should consider discussing your options with a qualified financial advisor.
Once you hit age 59.5, you can generally access your retirement money without penalty. As mentioned earlier, if you’re withdrawing from a pre-tax, traditional 401(k), you’ll get to skip the penalty, but you’ll still have to pay ordinary income tax on any money you take out.
59.5 is really the key age to remember when it comes to making penalty-free withdrawals, unless you fall under one of the less-common exceptions to the rule.
Yes, you can cash out your 401(k) plan at age 62, but it’s likely going to cost you a pretty penny in federal, state, and local income taxes, depending on where you live. So much tax, in fact, that you’d be depleting your nest egg within the confines of a single tax year.
As an example, cashing out a $1,000,000 401(k) at age 62 would allow you to bypass the 10% penalty, but you’d be on the hook for a tax bill in the $400,000 to $500,000 range depending on your state of residence. This is an astonishing amount of tax, so you’ll want to be very careful around any language that has you “cashing out” all at once.
Perhaps a more clever strategy would be to withdraw gradually from your 401(k) so as to never pay more than a specified amount of tax in any given year throughout your 60s. Recall that tax is charged on total income, not just the amount you withdraw from your 401(k) – so be sure that you take into account your entire financial picture before cashing out any account too abruptly.
The first part of this article centered around the age at which you can finally take money out of your retirement plan; once you hit age 72, you’re now required to take a certain amount of money out based on your life expectancy.
These mandatory withdrawals, also known as Required Minimum Distributions, or “RMDs”, kick in as soon as the 401(k) owner turns age 72. While these withdrawals won’t be penalized in any way, they will be taxed as income at your highest marginal rate.
If you have RMDs in retirement, it’s key to understand them in the context of all your other income. RMDs can drive up your total income to a higher tax bracket, so it’s imperative as you approach retirement to get a sense of how required distributions affect your overall tax bill.
Note that with the very recent passage of Secure Act 2.0, the RMD age has increased to 73. The RMD age will increase again in 2033 to age 75.
An IRA rollover isn’t the same as a 401(k) withdrawal, but it is another way to remove money from your employer-sponsored retirement plan.
Recall that when you take money out of an employer plan, like a 401(k), you will pay ordinary income tax as well as a potential penalty depending on your age.
When you roll money to an IRA, you won’t pay a penalty or income tax. While an IRA rollover won’t give you access to your money, it will change the location, institution, and account type associated with your retirement account. You can select either a traditional IRA or a Roth IRA depending on your preferences. Qualified withdrawals from a Roth IRA are tax-free.
You’d generally look to an IRA rollover if you’ve left a previous employer and want greater control over your investments and simplify your finances by consolidating multiple 401(k)s into a single IRA account. It could also be a good option if you want to change the investment approach; such as moving to a robo-advisory account from a self-directed account. If you’re not sure how to find your old 401(k), you can contact your old plan administrator or use your social security number to look up the provider.
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