When is it okay to make an early withdrawal from a 401(k)?

Accessing your 401(k) early might feel like a lifeline during financial stress. Whether you’re facing mounting medical expenses, a sudden job loss or trying to quickly pull together the down payment for a house, the idea of tapping into that retirement account can be tempting. 

But there are serious trade-offs. Making an early withdrawal from a 401(k) comes with consequences that can undercut your future financial stability. Not only can you lose out on long-term potential growth, you’ll also owe income tax and possibly a 10 percent early withdrawal penalty if you haven’t reached age 59½.*  

Still, there are a few situations when early withdrawal from a 401(k) may be allowed, or at least less costly.* The key is understanding when it’s possible, what penalties apply and whether other strategies — like a 401(k) loan, for example — make more financial sense for your situation. 

What is considered an early withdrawal from a 401(k) and why is it discouraged? 

The Internal Revenue Service (IRS) defines an early or premature withdrawal as any distribution from a retirement account before age 59½. This applies to a range of tax-advantaged accounts, including a 401(k) plan, traditional IRA or SEP IRA. 

When you take money from your retirement account early, you’re usually “hit twice” with taxes. First, you’ll owe regular money at your income tax rate on the amount you withdraw. Then you’ll also face a 10 percent early withdrawal penalty, unless you meet a specific exception outlined by the IRS.* 

In addition to the tax consequences, early withdrawals interrupt the compounding growth of your investments — one of the most powerful tools for long-term wealth building — and could mean missing out on years or even decades of retirement savings potential. 

Hardship withdrawals from a 401(k) 

Some employers allow 401(k) participants to take what’s called a “hardship withdrawal.” These are meant for urgent needs and come with strict eligibility requirements. To qualify, the withdrawal must be due to an “immediate and heavy financial need” and “must be limited to the amount necessary to meet that need,” according to the IRS.* 

Eligible expenses typically include: 

• Medical expenses for you, your spouse, dependents or beneficiaries 

• Certain costs related to purchasing a primary residence (excluding mortgage payments) 

• Tuition, related fees and room and board for postsecondary education for you or a dependent 

• Payments that are necessary to avoid eviction or foreclosure 

• Certain expenses to repair damage to your primary residence 

• Funeral expenses  

Hardship withdrawals are still taxed at your regular income tax rate, but you would be able to avoid the penalty of 10 percent.*  

Penalty-free exceptions for early withdrawals

There are additional situations where the 10 percent early withdrawal penalty may be waived — but they do not qualify as hardships — though again, you’ll still owe income tax. These exceptions are built into tax law and apply only to specific circumstances. Common examples include: 

• Birth or adoption of a child: distributions up to $5,000 per child 

• Permanent disability 

• Certain federally declared disasters: up to $22,000 if you live in an affected area 

• Emergency personal or family expenses: one withdrawal per year, up to $1,000 

• Military reservists called to active duty for 180+ days 

Before assuming you qualify, confirm with your plan administrator or a tax advisor. Some plans have stricter rules or require documentation for exception claims. It’s also worth noting that while these exceptions reduce penalties, they still impact your future retirement balance. 

The rule of 55: early access without a penalty 

The IRS offers one important exception to the early withdrawal penalty known as the rule of 55. If you leave your job (or are laid off) in the calendar year you turn 55 or older, you can take distributions from your current 401(k) plan without paying the 10 percent early withdrawal penalty.* You’ll still owe income taxes on the amount, but this rule can provide much-needed flexibility if you’re retiring early or between jobs and need access to cash. 

This only applies to the 401(k) or 403(b) plan associated with the employer you just left. It doesn’t apply to IRAs or older employer plans unless you consolidate them under the current plan. Timing and plan specifics matter, so it’s best to consult your HR team or plan provider before making decisions. 

Public safety employees — including police officers, firefighters, EMTs and air traffic controllers — can take advantage of this rule starting at age 50.* 

401(k) loans: Another way to access your funds without taking an early withdrawal 

If your employer offers it, a 401(k) loan can be a more manageable way to access retirement funds without triggering taxes or penalties.* A 401(k) loan allows you to borrow from your own account and repay it, with interest, usually through automatic payroll deductions. 

Pros: 

• This type of loan doesn’t require a credit check. 

• The interest you pay goes back into your own retirement account. 

• It can be helpful in situations like paying off high-interest credit card debt, covering temporary cash flow issues or building up a down payment for a house. 

Cons: 

• 401(k) loans may include origination or maintenance fees that increase the overall cost of borrowing. 

• While your money is loaned out, it isn’t invested in the market, which could mean missing out on potential growth. 

• Some plans pause employee contributions while a loan is active, which can affect employer matching and future savings. 

• If you leave your job with an outstanding balance, you typically have until the tax filing deadline (plus extensions) to repay it. Otherwise, the unpaid amount is treated as a distribution and subject to taxes and a 10 percent penalty. 

Before taking this step, be sure to review your plan loan policy carefully and consider how it may affect your long-term retirement outlook. What seems like a quick fix today could have lasting effects on your financial future. 

Know your options before you tap your 401(k) 

Making an early withdrawal from your 401(k) is rarely the best first step, but in some cases, it can be a reasonable one — especially if you qualify for a penalty-free exception or have no other viable options. 

Before you withdraw money, explore other resources like a personal savings account, budget adjustments or a home equity line of credit. Review your 401(k) plan options for loans or hardship withdrawals and confirm your eligibility for any penalty-free exceptions. Speak with a financial advisor if you’re unsure about the best route forward. And if you’re about to turn 55 or 59½, it may be worth timing your withdrawal to minimize penalties and tax obligations. 

Your 401(k) is one of your most valuable tools for long-term financial security. Making an early withdrawal from your 401(k) should be a last resort, but when necessary, it should be done with a clear plan and full understanding of the trade-offs. 

 

*Tax laws are subject to change. Contact a tax advisor for more details.