Penalty Tax at 10%
Withdrawals from a 401(k) account prior to age 59.5 are typically subject to a 10% penalty tax unless there are special circumstances. The 10% rate applies to the amount withdrawn. You will also pay income tax on the withdrawn amount itself.
Note: Contributions rolled over to another plan are not subject to the penalty tax.
If You’re Still Employed by the Company
401(k) plans often do not allow for “regular withdrawals” at age 55 while you are still employed by the company. A regular withdrawal is defined as a withdrawal that is not subject to penalties and does not require qualification based on special circumstances.
You may be able to take a 401(k) loan or qualify for hardship withdrawals instead of making a regular withdrawal if your 401(k) plan allows for these options. However, not all 401(k) plans are required to offer loans or hardship withdrawals.
Note: You can check with your plan administrator to see if they have a special arrangement that allows something called “in-service distributions.”
If You Transferred to Another Job
The rules differ if you want to withdraw funds from an old 401(k) account at an employer you no longer work for. It does not matter why you left the job – whether you were fired, laid off, or resigned – as long as you are no longer employed there.
You can make withdrawals from your 401(k) account in this case either during the year you turn 55 or afterward. The withdrawn amount is considered taxable income, and the former employer must withhold 20% of the withdrawal amount for income tax, but it will not be subject to the 10% penalty tax imposed before age 59.5. It is also possible to receive a refund of part or all of the 20% withheld if the withheld taxes or estimated tax payments during the tax year exceed your final tax liability – that is, what you owe to the IRS.
Note: This rule applies at age 55 before five years, at age 50, for qualified public safety employees.
This early exception does not apply if you rolled over the old 401(k) plan into an IRA, and employers are not legally required to allow such withdrawals.
If You Left Your Former Employer Before Age 55
The 55 rule exception does not apply if you left your former employer before turning 55, or age 50 for public safety employees, even if you are over age 55 now. Any withdrawals you make will be subject to the penalty tax unless you are able to roll over your 401(k) plan into an IRA and meet the conditions for a penalty exception.
Note: Your date of leaving the job with the working company is the critical factor, not the date you start the withdrawals. This date must meet the 55 rule.
Planning Opportunities
The funds in your 401(k) account are protected from creditors, and you will lose this protection if you withdraw from your 401(k) plan early.
It may make sense in some cases to leave the funds in your 401(k) account until you reach age 59.5 if you intend to retire early before age 60. This gives you the option to withdraw if you need to.
It may also make sense to wait until the year you turn 55 if you can retire at age 54. You will have more access to your 401(k) funds and can make withdrawals that are not subject to the early withdrawal tax.
Inherited 401(k)
These rules do not apply if you inherit a 401(k) account. The rules in this case will depend on whether you are a spouse or non-spouse and the age of the 401(k) account holder at the time of death.
The rules change
Tax laws change periodically. You should always consult a tax professional for the latest advice. The information in this article is not intended as tax advice and does not replace tax consultation.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy and reliability of our content.
Internal Revenue Service (IRS): “Topic Number 558: Additional Tax on Early Distributions from Retirement Plans Other than IRAs.”
Internal Revenue Service (IRS): “Retirement Topics – Tax on Early Distributions.”
Source: https://www.thebalancemoney.com/401k-withdrawals-at-age-55-2388222
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