Early 401(k) Withdrawals: Tax Questions to Ask

When money is tight, a 401(k) balance can look like the easiest place to find cash. Taking money out early, though, can bring taxes that surprise people at filing time. This guide explains the basic federal rules in plain language and lists questions to ask before you withdraw. It covers federal tax only. State tax rules differ, and your plan's own rules also matter.

What counts as an "early" withdrawal

The IRS explains that, generally, early distributions are those you receive from a qualified retirement plan before reaching age 59½ (IRS Topic No. 558). A 401(k) is one of the plans covered.

According to the IRS, to discourage using retirement money for other purposes, the law imposes a 10% additional tax on certain early distributions. That additional tax applies to the part of the distribution that is included in your gross income. It is in addition to regular income tax, not instead of it.

Question 1: Will the whole amount be taxed as income?

Often, much of a 401(k) withdrawal is included in your income for the year. That can raise your tax bill and, in some cases, change your eligibility for credits or benefits tied to income. Ask your plan or a tax professional how much of your withdrawal will be taxable. Amounts from after-tax or Roth contributions may be treated differently.

Question 2: Does an exception apply?

The IRS lists many exceptions to the 10% additional tax. For qualified plans such as a 401(k), the IRS lists exceptions that include, among others:

• Distributions after you separate from service with your employer in or after the year you reach age 55.
• Distributions because you are totally and permanently disabled.
• Distributions to you because you are terminally ill.
• Distributions to your beneficiary or estate after your death.
• Distributions to an alternate payee, such as a former spouse, under a qualified domestic relations order.
• A series of substantially equal periodic payments, if certain conditions are met.
• Distributions to the extent of deductible medical expenses above a set share of your income.
• Distributions due to an IRS levy on the plan.
• Certain distributions after a federally declared disaster, for qualified birth or adoption expenses, for victims of domestic abuse, and for personal or family emergency expenses.

Each exception has its own conditions and, in some cases, a dollar limit. Some exceptions apply to IRAs but not to 401(k) plans, and the reverse is also true. The IRS table shows which apply to which kind of plan. Do not assume an exception fits until you have checked its exact terms.

An exception to the additional tax does not usually mean the money is tax-free. Regular income tax may still apply.

Question 3: Is this a withdrawal or a rollover?

The IRS says distributions that are not taxable, such as those you roll over to another qualified retirement plan, are not subject to the 10% additional tax. If you are changing jobs and moving money to a new plan or an IRA, ask how to do a direct rollover so the money is not treated as a withdrawal.

Question 4: Is a loan or hardship distribution an option?

Some plans allow loans, and some allow hardship distributions. These are plan features, so your plan decides whether they are available. The IRS has a page on hardship distributions. Ask your plan administrator what your plan offers and what the tax effect would be. The IRS notes that a hardship distribution may still be subject to the additional tax.

Question 5: Will enough tax be withheld?

The IRS notes that distributions from a qualified plan are subject to federal income tax withholding, but if the distribution is subject to the 10% additional tax, the withholding may not be enough. You may need to make estimated tax payments. Ask what will be withheld and estimate what you might still owe.

Question 6: What forms will I see?

Your plan will usually send Form 1099-R reporting the distribution. The IRS explains that the additional tax is reported on Schedule 2 of Form 1040, and that in some situations you must also file Form 5329, for example when an exception applies but the distribution code on Form 1099-R does not show it. Keep the 1099-R and any records that support an exception.

Question 7: How does this affect my retirement?

Money withdrawn early no longer grows for retirement. USAGov's retirement planning tools page links to planning worksheets and Social Security estimates that can help you see the bigger picture before you decide.

When to talk to a tax professional or lawyer

Many people handle a simple withdrawal with their plan and a tax preparer. A tax lawyer may help when:

• You already took a withdrawal and received an IRS notice about it.
• You believe an exception applies but your 1099-R does not show it.
• The withdrawal is part of a divorce, a court order, or an estate.
• You owe tax you cannot pay.
• A large amount is involved.

If you received an IRS bill you disagree with, USAGov's page on resolving tax disputes describes the Taxpayer Advocate Service and Low-Income Taxpayer Clinics, which may help for free or at low cost.

Frequently asked questions

Is the 10% additional tax the only tax on an early 401(k) withdrawal?

No. It is an additional tax on the taxable part of the distribution. Regular income tax may also apply, and your state may tax it too.

Does leaving my job at 55 change anything?

The IRS lists an exception for distributions after you separate from service with your employer in or after the year you reach age 55. Conditions apply, so check the details.

Do I have to file Form 5329?

Sometimes. It depends on the distribution code on Form 1099-R and whether you claim an exception. See the IRS instructions or ask a tax professional.

Are hardship distributions taxed?

The IRS says hardship distributions are subject to income tax unless they consist of Roth contributions, and they may also be subject to the 10% additional tax on early distributions.

Related: Browse more legal guides and tax lawyers.

General information, not legal advice. Laws change and every case is different — talk to a licensed attorney about your situation.