Table of Contents
What are penalty-free retirement withdrawals?
Reasons to withdraw penalty-free funds
Withdrawals vs. loans
Early retirement options with the rule of 55
The bottom line
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Saving for Retirement
How to Take Penalty-Free Withdrawals From Your Retirement Account
How to Take Penalty-Free Withdrawals From Your Retirement Account
Sep 12, 2022
5 min read
Withdrawing retirement savings before retirement age usually will trigger an early withdrawal penalty. Learn about a few exceptions that may not apply to this case.
There are many rules surrounding tax-advantaged retirement accounts. Whether the money is in a 401(k), individual retirement account (IRA), or another type of account, investors must follow IRS guidelines on everything from contribution limits to when to withdraw money.
Pulling money from a retirement account before a certain age can trigger penalties, in addition to any taxes owed on the funds. However, there are a few exceptions. Here’s a look at how to make penalty-free withdrawals from various types of retirement accounts before retirement and what to expect from the process.
As the name implies, a penalty-free withdrawal occurs when an account holder pulls money from a retirement account without incurring punitive fees. Withdrawing retirement savings from a 401(k) or IRA before age 59 ½ will usually trigger an early withdrawal penalty of 10%. This penalty is in addition to paying income taxes on the funds, if applicable.
Traditional individual retirement accounts, or IRAs, may waive the penalty on an early withdrawal in a handful of circumstances. Previous contributions (money deposited into the account) can be withdrawn from a Roth IRA at any time without penalty or taxes. In either case, funds cannot be repaid into the account, with the exception of eligible coronavirus-related withdrawals, per the CARES Act of 2020.
401(k) plans may allow loans and penalty waivers in certain circumstances that constitute hardship. Some 401(k) plans may also allow loans.
There are a few reasons an account owner may want to withdraw retirement funds from an IRA or 401(k) account before reaching retirement age. In the following situations, those withdrawals may be free of penalties. Be aware that rules vary by account type.
In general, IRAs permit penalty-free withdrawals in more circumstances than 401(k)s. However, 401(k)s permit loans; IRAs do not—more on that below.
Note: Withdrawals from 401(k) plansmay be allowed for these events, but they will incur taxes and penalties.
Funds can be pulled from an IRA ahead of retirement age to pay for qualified higher education expenses.
Qualified homebuyers can withdraw as much as $10,000 from an IRA to put toward their first home purchase, without penalty.
An IRA owner who is unemployed can take early withdrawals to pay for health insurance premiums without incurring a penalty fee.
Both IRA and 401(k) account owners can take certain qualified distributions from their retirement accounts if they are a military reservist who is called to active duty for 180 days or more.
If unreimbursed medical expenses total more than 10% of the account owner’s adjusted gross income for that year, early distributions are allowed from both a 401(k) or IRA without penalty.
Early withdrawals can be taken without penalty in the case of a total and permanent disability of the participant/account owner. This applies to both IRAs and 401(k) plans.
, up to $5,000 in qualified distributions can be taken from an IRA if the account owner adopts or gives birth to a child.
If an IRA or 401(k) account owner dies and passes the plan to a beneficiary, that beneficiary can withdraw funds from the account without penalty. As of 2020, inherited IRA distributions must be taken entirely by the end of the tenth year following the original account owner’s death.
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Some 401(k) plans allow an option for accessing funds that IRAs do not: taking a loan. Loans must be repaid, while early distributions do not.
Not all 401(k) plans allow loans; it’s up to the plan sponsor to decide whether loans are allowed in the first place. If offered, 401(k) loans may be eligible to take up to 50% of the account balance or $50,000, whichever is less.
If a loan is allowed, participants aren’t required to explain their account loan or how the money is being used. However, in some instances, the participant’s spouse will also need to sign off on the loan, since it’s considered a marital asset. Participants must repay the borrowed amount plus interest within a specific period of time (usually five years). If the funds are not repaid, penalties may be incurred.
There is another early retirement penalty exception for 401(k) plan contributors laid off in the years preceding retirement. This is commonly referred to as the rule of 55.
If someone quits, is fired, or is laid off after age 55 but before they reach 59 ½—when penalty-free distributions are allowed—a 401(k) plan contributor may be able to take early withdrawals and have the penalty fees waived. This exception also extends to qualified public-safety employees who separate from service in or after the year they turn 50, or those accepting dividends from an employee stock ownership plan.
IRA retirement plans are excluded from the rule of 55.
Saving for retirement may involve different types of retirement plans, such as an IRA or 401(k). The IRS offers many advantages to future retirees saving with these accounts, but there are also some important guidelines to follow—namely, when those funds can be withdrawn without penalty.
There are some exceptions to these IRA and 401(k) withdrawal rules, which allow account owners to take early distributions without incurring additional penalties. These exceptions are specific and may not apply to all types of retirement accounts.
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