When unanticipated circumstances unfold, an account holder can draw money out of a 401(k) without penalty if it’s a qualifying event. A non-qualifying early withdrawal from a 401(k) typically results in a 10% penalty tax and payment of the standard income tax rate. If you meet the requirements for an early hardship distribution, you can tap into these funds in your time of need.
Qualifying standards for early withdrawal
Many people wait until age 59.5 to start taking funds out of a 401(k) account. Funds in 401(k)s are not available for early withdrawal without penalty, according to the Internal Revenue Service (IRS) until you meet the standards for an exemption. An exemption can be one of the following:
- A death. While this is not a pleasant subject, death does qualify for early withdrawal. If the account holder dies before age 59.5, then the financial institution will distribute 401(k) to the account holder’s benefactors.
- 55 and no longer employed. First, the reason for leaving your employer is irrelevant. If the 401(k) is associated with your last employer, you can draw on the account penalty free by age 55.
- Disability. When social security or an insurance company has classified you as disabled, you have the discretion to draw funds from your 401(k) account without penalty. This allows you to pay for medical bills and other health care expenses.
- Medical bills. This is a viable option if you have a qualifying medical event and you need the money to pay bills. If you’re withdrawing in the same year, you can take out money to pay the bills as they come due. Or you can withdraw up to 7.5% of adjusted gross income to pay these bills.
- Disaster relief. If you live in an area that has been designated for disaster relief, you can draw on your 401(k). Extreme weather events, wild fires, mud slides, tornadoes and hurricanes are more common in recent years, and this allows account holders access to additional financial resources in a time of need.
- Exercise 729(t). According to this clause in the 401(k) disbursement laws, you must take out roughly equal periodic payments, and these received payments must remain equal for the duration of the withdrawal period. Therefore, if you must take out unequal payments, the rules assess a 10% penalty on all funds withdrawn up to that point.
A 401(k) is not unavailable for early withdrawal without penalty if certain conditions are met, but thankfully, the IRS takes major unforeseen life changes into account to allow early withdrawals.