Retirement Life Golfing In Hawaii

When Can You Withdraw From Your 401k Or IRA Penalty Free?

in Retirement Planning by

If you’re forced to tap retirement funds early, you’d better know the rules.

401ks, IRAs and other pretax retirement savings accounts are now the most common way to save for retirement, and millions of Americans pour money into them every year. Unfortunately, millions more take early withdrawals from these accounts due to hardship, loss of a job or other money woes.

If you take a distribution from an IRA or a 401k before the age of 59 ½, you’re assessed a 10% penalty tax in addition to any other taxes you owe. That adds up. According to a very revealing IRS tally of tax returns, in 2011 Americans paid over $5 Billion in early withdrawal penalties alone!

If you desperately need the money, the 10% early withdrawal penalty is probably not much of a barrier. However, before you pay up you should know some useful exceptions and loopholes in the laws that govern retirement accounts. These exceptions may make it possible for you to tap your retirement savings in a time of need without having to pay the IRS for the privilege. They require some planning and care to implement, so it’s best to know about them before you need them.

Retirement funds locked away?

I first had the opportunity to invest in a 401k account when I was 22 years old, just after college graduation. But the realization that the money was essentially gone, and would be locked away for a period longer than my entire lifetime at that point was worrisome. Age 59 ½? I felt like I was saving money for an entirely different person!

The easy way to solve this problem was to contribute to a Roth IRA. Because my contributions to the Roth were after-tax, I knew I could withdraw them immediately with no penalties. Any earnings on the contributions would still be restricted, but knowing that I could access some of my retirement money was a comfort.

Unfortunately, most of my money was going into a 401k, and there was no Roth option. In an effort to feel more comfortable while salting away my earnings, I put together a list of situations wherein I could access my money if I really needed it. I’ve since updated the list, and am sharing it below. I’ll do you a favor and skip over the items that deal with death or complete disablement. In that case, a penalty tax is not likely to be top of your concerns.

Keep in mind that although these exceptions enable you to avoid the 10% penalty, you will owe income tax on any IRA distributions. Also remember that these are broad outlines. Anyone wanting to tap retirement funds early should talk to their Personal Capital financial advisor.

REASONS FOR PENALTY-FREE RETIREMENT FUND WITHDRAWALS

Education:

You are allowed to take an IRA distribution for qualified higher education expenses, such as tuition, books, fees and supplies. This distribution is taxed at your ordinary income rate, but there won’t be a penalty. For instance, if you want to go back to graduate school and you need the money, you can decide to tap your retirement fund for tuition. The rule also allows you to apply this exception to your spouse, children or their descendants.

First-time home purchase:

You can take up to $10,000 out of your IRA penalty-free for a first-time home purchase. If you are married, your spouse can do the same. And “first-time home” is defined pretty loosely. For the purposes of the IRS, it is your first-time home if you have not had an ownership interest in a home for the past 2 years. Just like the education exclusion, you can also tap this option for the benefit of your family. Your children, parents or ancestors may receive the same $10,000 for their purchases, even if you’ve used this benefit for yourself previously or already own a home.

Medical expenses or insurance:

If you incur unreimbursed medical expenses that are greater than 10% of your adjusted gross income in that year, you are able to pay for them out of an IRA without incurring a penalty.

Create an Annuity:

Unbeknownst to me until right before this article, you can begin taking distributions from your IRA without penalty, anytime you want, by taking a 72t early distribution. It is named for the tax code which describes it, and it allows you to take a “Series of Substantially Equal Periodic Payments”, based on a calculation involving your current age and the size of your IRA. More details here.

The catch is that once you start, you have to continue taking the periodic payments for five years, or until you reach age 59 ½, whichever is longer. Also, you will not be allowed to take more or less than the calculated distribution, even if you no longer need the money. So be careful with this one!

What if you only need the money short term?

So although there are other qualifying exceptions to withdraw IRA assets penalty-free, those are the major ones. But suppose you’re not interested in paying any taxes at all. You can still use your 401k to borrow money from yourself while paying interest to yourself, without it being a taxable event or showing up on your credit report. Here’s how:

401k loan:

You are allowed by the IRS to borrow against your 401k, provided your employer permits it. Your employer will administer and set the terms of the loan. The maximum loan amount permitted by the IRS is $50,000 or half of the 401k, whichever is less. During the loan, you pay principle and interest to yourself at a couple points above the prime rate, which comes out of your paycheck on an after-tax basis. Generally, the maximum term is 5 years, but if you use the loan as a down-payment on a principal residence, it can be as long as 15 years.

The benefits of such a loan are obvious. You do not need a credit check, nothing appears on your credit report, and interest is paid to you instead of a bank or credit card company. The interest rates are usually lower than what you could receive elsewhere, and the paperwork is not complex.

Now the downsides: If you leave your leave your employer (or are fired), your loan is generally due right away, usually within 60-90 days. If you can’t pay it back, you will be assessed a penalty by the IRS. Also, taking a 401k loan depletes your retirement principal and will cost you any compounding that your borrowed funds would have received.

IRA Rollover Bridge loan:

There is one final way to “borrow” from your 401k or IRA on a short-term basis, and that is to roll it over into a different IRA. You are allowed to do this once in a 12 month period. When you roll an account over, the money is not due into the new retirement account for 60 days. During that period, you can do whatever you want with the cash. However, if it’s not safely deposited in an IRA when time is up, the IRS will consider it an early distribution and you will be subject to penalties on the full amount. This is a risky game and is not recommended, but if you want an interest-free bridge loan and are sure you can pay it back, it’s an option.

DO YOUR BEST TO NEVER WITHDRAW

Despite the reasons allowing you to withdraw penalty-free, do your best never to touch your retirement funds until you’re retired. The ability to compound your earnings pre-tax is a major contributor to having a financially rock solid retirement. However, it remains your money even before you retire, and knowing the rules of the game can allow you to make informed decisions and avoid having to pay needless fees and taxes. Don’t contribute to the billions of dollars going to the IRS in penalties every year, if you can possibly avoid it. They receive enough already.

Readers, have you ever tapped your retirement funds early for an emergency or one of the reasons above? 

Photo: Golf course in Hawaii with Hawaiian islands as sand traps.

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Matt Lenore

Matt Lenore

Matt Lenore is a Research Associate at Personal Capital. He left a traditional portfolio manager to join Personal Capital to be part of revolutionizing the wealth management industry. When he's not trading, he loves tracking the markets and scheming about investment strategy. He graduated cum laude with a degree in economics from Brandeis.

50 comments

  1. Donna

    Hi Matt, you’re a “gem”‘ the information provided is invaluable.
    Can you borrow from Roth IRA to pay student loans? Thanks Donna

    Reply
    • JT

      You cannot borrow from an IRA. This is a feature of a 401K. However, even if you could, paying student loans would be a poor reason to access that money. Student loans are low interest debt, usually lower interest than the stock market produces. Taking money out of an account that pays you 8% interest to pay an account that charges 6% interest does not make sense. If these are not federal student loans you might have higher interest rates, but it is still unlikely that you will improve your financial situation by using retirement accounts to pay of student debt.

      Reply
  2. Financial Samurai

    Good post Matt. The biggest concern I’ve noticed is that there seems to always be an emergency for folks who start withdrawing from their 401k or IRA for something. Better to make it like the Singapore or Australia system. Those guys retire with much greater sums of money due to better contributions from the employer/gov’t and more difficulty in withdrawing.

    Reply
    • Julia

      Good Article Matt, thanks- I’ve learned a few things/prior to 59.5 yr old wdwls! So, I’m sharing and hoping that someone might benefit. At FS ~Yes, I did all the right things: 401K, IRAs, emergency savings, no car payments, no credit cards debt, etc,,, However, a drastic financial change like a (Forced) VRP – voluntary resignation program/Buy Out Offer~ where, you’re damned if you do and 2x damned if you don’t because…. I was (sultry) threaten with lay-off w/No Severance and loss of pension if I chanced the laid off!
      Now, the rock and hard place decision ~ I accepted and signed on the dotted line at 52 yr (female) w/ a “bridge” guaranteed Emp for 1yr ‘tiill 53.5 yrs old on 6/2010 – it helped that I’m a new year’s baby! I received 19 months of weekly severance w/paid med insurance (I put in 32 yrs) but, they never told me – not for lack of asking – how much my pension will be and my retiree medical ins (self+1).

      Well, thank God that I was sitting down, when they gave me the figure, I almost Passed Out! The Bastards Knew that this sum is a only a little over 1/3 of my prev and I has to pay $350 med Ins! I ended up having to take the SSI Option in order to have a semblance of income for living exp. I was still about $1,000 short! So, after I exhausted all expense cuttings, sold my gold jewelry $8K -luckily Gold was $1600 an oz., FOUGHT 2 Major Bank Sharks and WonL CHASE $39K/Settlement $5.9K, WFC/Refi from $1124 to $748. I Had to TAP into my Personal ROTH IRA to pay Chase $5,900 for a $39,000 equity loan balance and cut $416 of my Monthlies ~ I think that was a very good reason.

      Note: I got an IRS notice in 6/2014 that I was being AUDITED for 2012 because of IRA/Roth early witdwl and that I owed $2,800 -by the rules “you can withdraw the Roth IRA contributions/Principal anytime without Penalty.” Well, I contributed $6K and I withdrew $5K in that 2012 year. THERE IS NO BOX ON THE 1099 Form THAT CAN BE CHECKED TO REFLECT CONTRIBUTION / PRINCIPAL WDWL. Instead, there’s a box that says EARLY WITHDRAWAL that’s the one the Financial Institution checks ~ I had used TURBO TAX 2012 and with all the stupid questions not one handled the IRA wdwl and tried as I may to enter the correct figures, it piled the IRA money on top of my regular taxable income for FED & STATE(found out in 2014) ; Although I omitted the IRA $ on the FED return, Turbo TAX had automatically added it to my STATE causing me to Pay about $850 that was not due! Since it was withdrawal of contributions– KEEP ALL YOUR ROTH and any other Contributions RECORDS. After filing an AMENDED Return -with the Competitor, the $850 was due to FED and STATE had to Refund me $590.

      Reply
  3. Jim

    How does the early withdraw apply to the ROTH 401k? If I contribute to a Roth 401k and roll it over to a Roth IRA can I take the contributed funds out as long as they have been in the Roth IRA for 5 years? Or does the contribution apply to the year you contributed to the Roth 401k?

    Reply
  4. Michael David Thomas

    Matt,
    Handsome *and* smart, you are truly a “dual-threat”. This is great information, keep up the blogging!

    Reply
  5. Frank Peng

    I enjoy reading your posts. One think you didn’t mention is that, for Roth 401k, if you leave your current job after 55, you can withdraw the money without any penalty.

    Reply
  6. Christopher Carriero

    Matt, am I able to borrow from my IRA to purchase a new home with no penalty or interest?

    Thsnks, Christopher

    Reply
  7. doris a overton

    Why would disability and soc sec funds be reported as taxable incoome?

    Reply
  8. stephen krage

    i am retired and took a distribution from my ira in the calendar year i turned 59 1/2 but before the actual date i turned 59 1/2. is that distribution subject to the 10% penalty?

    Reply
    • Anonymous

      yes

      Reply
    • mike

      was this answered ? seems like years ago it was ok without 10% penalty to take out money
      in the year you reached 59.5 even if you had not reached the actual 59.5

      for example if i am 59.5 on june 10th in 2016, i can take out ira with no penalty in 2016 – thats how the irs rules used to read, i think

      now, it’s not until after reaching 59.5 in actuality – so june 8th 2016 I would pay the 10% (if no exceptions) and on june 11th 2016 I would not pay the 10% is that how it works now?

      Reply
  9. Anonymous

    Matt, I am turning 60 on July 2. My Mom has passed away in May and left me her IRA, so can I take this without tax penalty?

    Reply
  10. Mary

    Hi, I am turning 60 next month, My Mom passed away in May. Can I take the IRA without penalty? I have no income as I cared for my Mom 24/7 for 8 years. She did leave me half of her home in 2009, then last Nov left the other half to me and my Husband. The half that she left us is assessed at $50,000 . My husband is disabled and is retired collecting social security. I basically have no income. Thank you in advance for your help! Mary

    Reply
    • Myra Cheek

      I am now 67.5 yrs old. Can is draw my money from my 401K to purchase a home without penalty?

      Reply
  11. Katie

    Hi,
    I will be attending law school in the Fall and I’m in need of outside funding until my student loans kick in. I have a 401k through my current company. I will no longer be employed once I start school. The company stated that there will not be any penalty for complete withdraw once I’m terminated from the company. I’m not sure if I should borrow the entire amount from my 401k OR just close it completely… (I have a state 401k that I will leave open). Also, do I just provide documentation come tax time that I used the funds for school?

    Reply
  12. Natasha

    Hi my fiance was at his previous job 16yrs he a
    Has a 401k n penision they say he has to wait for 1 year but we have ran into emergency critical situations and need $$ bad. How and is there any way through whoever or however to get some of his $$???

    Reply
  13. Anonymous

    If you are mpsing your home due to job lose and hardship can you take out 4401k without penalty to be able to pay it off. If not i might be homeless

    Reply
  14. Lisa

    I have a 401k. I am 52 years old. All I have is $20,000. How much money will be held back if I cash it in. I have exhausted my unemployment. I have no idea what to do. Help me please!

    Reply
  15. josep illery

    i will be 60 in october i am on social security disabitlity my car was impound last month can i get a loan from retirement i work on the job for 18 years and was laid off in 2003 then i apply for social security in 2005. can i get some help from somebody.

    Reply
  16. joseph illery

    let me know the phone number to call for a loan ftom my pension

    Reply
  17. Lori Smith

    I have an IRA account. I will be 61 in Feb 2016. I am a widow on SSDI I own my home. However there are some things that I need to do to maintain the upkeep of my home. I want to withdraw 5,0000.00 .Is there only certain times a year when this can be done? I think I am allowed 4,100.00 tax free how much tax will I owe? Should I have them pretax me so I don’t have to worry about at tax time? What else is important that I need to know before doing this?
    Please answer promptly.

    Thank You.

    Reply
  18. bob byman

    Hi, if i am under the age of 59.5 and withdrawing from my ira do i have to pay the addit. 10% tax penalty if i take a distribution and use it for a pre paid tuition plan, ie florida pre paid. My daughter is only 2 and won’t be using the $ for another 16 years but i want to take advantage of pre paying for the tuition now and I have money that i can take out of my ira now to pay for this expense and it will be eventually used for tuition. Very confusing b/c I am not using the money for tuition this year but I will be paying the tuition via florida pre paid for college this year.

    Reply
  19. Tamara

    Can I withdraw from my 401k without being penalized to pay beck Irs taxes

    Reply
  20. Clarence Snyder

    Thank you for all of the information on 401K’s, IRA’S etc. I have a question for you that kinda takes a left turn from all of that though. 5 years ago I was relieved of my job with a food distribution company that I have worked with for 3 years and during that time I had invested over $3,000 into a 401k. I have never asked nor have I ever received information about my investment what I can do with it what I need to do with it ,

    Reply
    • Clarence Snyder

      I’m actually just curious if that money I invested is still mine, I am assuming that what I invested is still mine but I would like to know how to go about claiming it, transferring it, investing it, whatever I need to do. Thank you.

      Reply
  21. Alba

    I have been with present employer for a year and a half…so contributions in 401k are very small. I took a small loan of $1500…paid fee of $125 so loan is actually $1375 …and agreed to pay it back over 5 years, with payment to come straight out of my salary. THEN my employer told all staff we were going to be taken over by another management company mid-December this year. Trouble is, this new employer doesn’t offer a 401k. I understand that the amount still in my 401k with old employer will just stay there and accumulate any interest…but what happens about the loan I took from my 401k? Will I be able to make a monthly payment plan with the company where the 401k is based, so that I don’t have to pay any penalties and taxes? I am 68 years old and working full-time.

    Reply
  22. harshad

    I am 69 when and how much money can I withdraw fro my IRA/401K ?

    Reply
  23. Douglas

    4/1/16
    I am 63 and interested in knowing if I can do the 401k loan withdrawal from a 401k of a previous employer that has been turned over to my management?

    Reply
  24. Raymond Pietrogiacomo

    Matt,
    I am 62 yrs.old.Can I pull some money out of my 401k plan without being penalized?

    Reply
  25. mason carlton

    After being in relationship for 8 years,my husband broke up
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    Reply
  26. Delys Thomas

    I am only 53 years of age. I am practically almost Homeless. Can I do a short term loan on my IRA? What is the penalty? And how much tme will I have to pay it back

    Reply
  27. Anonymous

    Hi I wanted to know if I can borrow money to purchase a new house .first time home owner here..and I have Roth not 401

    Reply
  28. Gladys Mullins

    I turned 59 on August 17, 2016 when can I start drawing from my 401k without any penalty? And are the tax you pay the tax bracket you fall in or is it different?

    Reply
    • Tamar Kuyumjian

      Tamar Kuyumjian

      If you are still working, you can start withdrawing at 59.5 (so late February of next year) without a 10% penalty. However, if it is an active 401k plan (meaning you still work at the company), you need to check with HR first as some companies allow for “in-service” withdrawals and some do not (they make you wait until you leave). If you retired after age 55, you are allowed to withdraw penalty free before 59.5 as long as you did indeed retire after 55 and you have not rolled the funds into an IRA. All money taken withdrawn from traditional 401k plans is taxed as ordinary income and falls into whatever bracket(s) that works out to.

      Reply
  29. Allison Inemer

    I was at my job for 13 years. I’m 54 years old. Last year, I went through a divorce, purchased a home (first time) and borrowed $40,000 from my 401k for the down payment. One month later, the company laid me off, telling me they were downsizing. I immediately worked out a payment plan and continued paying on my loan. However, once I received a permanent job offer, I rolled my 401k funds from my former employer’s fund to my new employer’s fund, and they deducted the loan amount that I took for the down payment. Now, I’m anticipating being hit with a 10% penalty plus taxes on the $40,000, (as if going through a divorce and losing my job wasn’t enough). I did not act in any negligent way. Are there any loopholes for not having to pay all those taxes and penalties? I acted responsibly by purchasing a home – not wrecklessly. Thanks for your advice.

    Reply
  30. Barbara H

    I Understand that we are allowed to request a hardship withdrawal to purchase our primary residence, but if we take this Hardship loan now, and lets say something unexpected happens in a year or 2 later, where we needed to take another hardship withdrawal. Is that allowed? How often or how long do we have to wait until we are able to do another Hardship withdrawal from 401k?

    Reply
  31. Leamon R

    At 59.5 I’ll still owe about $10,000 on a loan from 401K and about $3500 on another. Could I stop paying on the $10000 loan and just consider it a withdrawal & pay taxes on it without penalty & just keep up payments in the $3500? Thanks

    Reply
  32. Donna

    I need to know what type of retirement plan I should have the attorneys set up for me. I am only awarded $35,000 and will have to take a huge amount out immediately for survival purposses. I’m 63 Yrs. Thanks Donna

    Reply
  33. Kimball Olsen

    my daughter has a 401k from her former company and wants to use it for a down payment on a condo what is the penaty amount or is there other form of making it go away

    Reply
  34. RICHARD LYMAN

    I’m 65 going on 66 still working, I want to take money out of my,.401 k to pay off my debt credit cards is this possible?

    Reply
  35. John K

    One of the most obnoxious features of 401ks is that they are taxed. I was in the same situation as Matt, namely there was no Roth IRA in existence when I first started saving and I just never got around to doing the Roth because I was already near retirement and somehow it the Roth IRA conversion seemed very punitive to me — take a hit on say $200k?? Are you crazy? So now I have to look forward to being taxed on any future IRA withdrawal. Thanks Uncle Sam!

    Reply
  36. Teresa

    I’m 68 and just retired. I have 54000.00 in my 401K. My disabled son is going through divorce and needs money to keep the house. He needs house to keep his medical trained pet due to his seizures. I don’t think I would pay penalty to take money out. Is investing this money in a home with my name and sons name wise?

    Reply
  37. Robert Tippett

    I am 61 1/2 is there anyway I can withdraw my 401k to keep my home out of foreclosure without paying a penalty ?

    Reply
  38. kesava murthy

    I am 66 and 67 in November. I have 401K and IRA through my job. How much i can withdraw without penalty and i think i have to pay taxes on whatever i withdraw right. There is a 4% or some such rule by IRS to must withdraw after certain age. Am i in that bracket now. How much each year and how long and if i am still working and contributing and taking tax deduction for my withdrawals per month what implications and what to look for . Also I am withdrawing 10% or less from IRA for my primary home purchase. This is not my first home but my wifes first home. Any help is appreciated.

    Reply
  39. Platinum Accounting

    You shared excellent information on about calculating the tax returns of a successful business easily by using online system software , I read this post and remember the best points especially ” customer service management ” mentioned in this article which help me for running a business successfully with the help of professional accounting .If you want to start a business successfully then you must read this article carefully and keep it in your mind all the best points of a great article which help you to running a business successfully with the professional accountant .
    Thanks

    Reply
  40. K. Murthy

    i am 66 and 67 this november 17. i would like to take out some of my 401K and or IRA for purchase of a house. will i pay penalty and or taxes at regular rate. Do i have some of the must take outs each year not sure 4 % or more and still would i have to pay taxes for that amount. At what age i should start taking out and what percentage. i am still fully employed and pay taxes. did not draw my SS yet. Any help and tips or suggestions so i dont lose i saved.

    Reply
    • Jamie Balkin

      Hi there, please make an appointment with one of advisors through the platform. They will be able to answer all of your questions regarding your 401k and IRA. Thanks!

      Reply
  41. S H

    My employer doesn’t allow outside contributions from another source.
    Is there a way to start a Roth IRA using Bit Coins ?
    Thank you kindly for any help. S.

    Reply
    • Jamie Balkin

      Hi there – thanks for reaching out! While holding bitcoin in an IRA has technically been possible since IRS Notice 2014-2 (which declared bitcoin property for tax purposes), the process remains complicated and fraught with liabilities. We would not personally recommend going down this path. I would suggest reaching out to an advisor for alternative options.

      Reply

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