Pre-tax retirement savings accounts such as 401(k)s and IRAs are common ways to save for retirement. Each year, millions of Americans pour money into these accounts. Unfortunately, many of those people find themselves having to pull money from their account early, due to unplanned financial circumstances. However, early withdrawing from your 401(k) account can mean sacrificing important benefits of your plan contributions and being subject to hefty fines.
If you decide to pull from your 401(k) before you reach at least the age of 59 ½, you’ll likely owe income tax on the amount you withdrew, plus an additional 10% early distribution penalty tax. These two penalties tend to add up and can mean cutting the amount you withdrew by a lot after paying taxes and penalties. Withdrawing from a 401(k) early is definitely not ideal, as you are not only losing money to taxes today, but also costing your future retired self even more. But, some individuals may have no choice but to tap into their retirement savings accounts. There are a few certain circumstances where the IRS allows exceptions to the 10% penalty.
Under these few circumstances, 401(k) withdrawals made before the age of 59 ½ may be exempt from the 10% early distribution penalty:
- You become disabled
- You die, and the account is paid to your beneficiary
- You incur unreimbursed medical expenses that exceed 7.5% of your adjusted gross income for the year
- Your withdrawal is related to a domestic circumstance, such as being court required to provide funds to a divorced spouse, children or dependents
- You begin a series of substantially equal payments (a 72t early distribution allows you to take a series of specified payments every year. The amount is determined by a calculation involving your current age and the size of your retirement account). Learn more here.
Even though there are ways to avoid penalty when pulling from your 401(k) early, it is recommended to not touch your retirement savings until you reach retirement. When you take early distributions, you lose out on the power compounding has when maximizing your retirement savings. However, we understand life happens and unforeseen circumstances arise, so it is important to educate yourself and be aware of the exceptions that exist so you can make informed decisions and avoid paying extra fees and taxes.