Hardship withdrawals avoid penalties
There are some scenarios in which you could make early withdrawals from a retirement account without paying the 10% early withdrawal penalty. These are known as hardship withdrawals. For 401(k)s, check with your employer about which hardship withdrawals apply to your plan and how to get approved. You may be required to verify that you don’t have any other available financial resources to satisfy your financial need.
Examples of hardship withdrawals for both IRAs and 401(k)s
- Birth or adoption of a child: Up to $5,000 in penalty-free withdrawals is allowed for each eligible birth or adoption.
- Certain military reservists: This includes military reserve members who are called to active duty for at least 180 days or for an indefinite period.
- Substantially equal periodic payments (SEPPs): Based on one of three available life expectancy formulas, a specific dollar amount is determined for distributions that avoid the 10% penalty when payments begin before age 59½. The distribution amount cannot be modified until the later of the 5th year anniversary of the first SEPP payment and the date you turn 59½. For example, if your SEPP payments begin at age 57, they must continue until age 62. And if you began your SEPP payments at age 51, they would need to continue to age 59½.
- Financial emergencies: The SECURE 2.0 Act added this new exception in 2024 that allows one penalty-free retirement account distribution of up to $1,000 per year to cover emergency expenses. These are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. An emergency distribution of pre-tax deferrals would trigger income taxes but could be repaid by the participant within three years.
Examples of hardship withdrawals for IRA, SEP, SIMPLE IRA and SARSEP plans only
- Medical expenses: These are defined as qualified medical expenses that exceed 7.5% of adjusted gross income.
- Higher education expenses: These include tuition, fees, and room and board for the next 12 months of postsecondary education for you, your spouse, or your children and dependents.
- Health insurance premiums while unemployed: This exception is available if you have received unemployment compensation payment for 12 consecutive weeks under a federal or state unemployment compensation law.
- First-time home purchase: Up to $10,000 in penalty-free withdrawals is allowed to pay for costs related to the purchase of a qualified principal residence.
See the IRS list of early distribution tax exceptions.
Loan vs withdrawal from your retirement account
When facing financial emergencies or cash flow shortfalls, it can be tempting to withdraw from a qualified retirement plan. However, Meilahn strongly discourages this.
“Withdrawing money from a retirement account early and paying penalties and taxes should be an absolute last resort after you’ve exhausted every other option,” she says. “Doing so can have a serious impact on your long-term retirement finances.”
If you really need to use the money in your retirement account before you’re 59½, Meilahn suggests taking out a 401(k) loan instead of taking an early withdrawal. Many 401(k) plans allow participants to borrow their own money and repay the loan via automatic payroll deductions. 401(k) loans usually must be fully repaid within five years unless the money is used to purchase a primary residence.
“Always look to a loan first if you don’t meet the qualifications for a hardship withdrawal,” says Meilahn. “You’re paying yourself back with interest and avoiding the 10% early withdrawal penalty. This also retains the tax benefits and keeps your retirement plan on track.”
The maximum 401(k) loan amount is $50,000 or 50% of the account’s vested value. Not all 401(k) plans permit loans, so ask your plan administrator about your plan’s loan provisions.
The “Rule of 55” and early retirement
Meilahn points out another unique early withdrawal circumstance. Known as the Rule of 55, this allows you to withdraw money from your 401(k) penalty-free if you leave your job or are laid off during the year in which you turn 55, or later. Income tax would still be assessed on the money you withdraw, but the 10% early withdrawal penalty would be waived.
“The Rule of 55 only applies to the 401(k) plan at your most recent employer, not previous employers,” says Meilahn. “This rule can be a useful tool if you want to retire between the ages of 55 and 59½.”
Early retirement withdrawals: Seek advice
It’s critical to understand the rules governing withdrawals from qualified retirement accounts. Otherwise, you could make costly mistakes that jeopardize your retirement financial security.
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