A third of Americans’ financial assets are held in retirement plans, according to data from the Investment Company Institute. In September 2024, those accounts represented more than $42 trillion in wealth.
For workers short on cash, dipping into a 401(k) account can be tempting. However, these accounts are meant for retirement, and there are often tax penalties for those who pull out money for other purposes.
“When your back’s up against the wall, you get money where you can get money,” says Tana Gildea, a financial advisor and principal with wealth management firm Homrich Berg in Atlanta.
Before taking an early withdrawal from a 401(k) account, understand both the short-term and long-term costs as well as other options you may have available.
[READ: How Much Should You Contribute to a 401(k) in 2025?]
Hardship Distribution vs. Early Withdrawal vs. 401(k) Loan
Retirement accounts come with tax advantages, and in exchange for those, the government stipulates specific rules for how 401(k) and similar plans are used. Chief among these is the requirement that withdrawals not be made before age 59 1/2.
Still, there are three ways people can tap into these accounts early.
— Hardship distributions. These are allowed for an “immediate and heavy financial need” and are limited to only the amount of money needed to address that situation. An early withdrawal penalty will apply to these distributions, and those taking a hardship withdrawal are prohibited from making elective contributions to a 401(k) plan for six months.
— Early withdrawals. Those who want to take money out of their 401(k) account before age 59 1/2 for other reasons may be eligible for an early withdrawal. Depending on the reason for the withdrawal, these distributions may or may not be subject to a tax penalty.
— Loans. Up to 50% of a worker’s vested account balance or $50,000, whichever is less, may be taken out as a 401(k) account loan. Loans typically must be paid back within five years. If a worker leaves their job with an outstanding loan, it must be repaid in full by the next tax filing deadline or it becomes a taxable distribution that may be subject to a penalty.
“If the plan allows for in-service loans, that might be a better way to go,” Gildea says. Interest from these loans is paid back to the account, which can help minimize the loss of investment gains while money is out of the market.
The financial impact of a hardship distribution or early withdrawal is more profound since it permanently reduces the value of a retirement account.
“It can set you back quite a bit because there is a limit on how much you can put in each year,” says Mike Policar, a fiduciary financial planner in Washington state.
In 2025, workers are limited to contributing $23,500 to their 401(k) plan. Depending on how much you withdraw and your contribution rate, it can take significant time to recoup the loss of cash taken out as an early distribution.
[Read: How to Take Advantage of 401(k) Catch-Up Contributions.]
Understand Your Plan’s Rules
While the IRS allows workers to tap into 401(k) plans using the above options, that doesn’t mean all workplaces permit early withdrawals or loans. The final decision on whether they are allowed rests with employers and plan administrators.
“Different employer plans may have different rules around whether they will even allow an early withdrawal,” Gildea says
Check your plan summary description to determine whether it allows hardship distributions, early withdrawals and/or loans. If you can’t find this summary, contact your employer’s human resources office or the plan administrator for assistance.
10% Penalty for Early Distributions
Assuming your plan allows for hardship distributions and early withdrawals, be prepared to pay tax on the amount you take out. All withdrawals from a traditional 401(k) plan are subject to income tax. With a Roth 401(k), only gains may be subject to income tax when making an early withdrawal. Contributions can typically be accessed without tax or penalty so long as the account has been open for at least five years.
In addition to income tax, hardship distributions and early withdrawals will likely be hit with a 10% tax penalty unless one of the exceptions outlined below applies. Between regular income tax and the penalty, workers could see a significant amount of money siphoned from their withdrawal for tax purposes.
“Really, the access is going to come in the form of a loan,” says Brad Clark, investment advisor representative and founder of Solomon Financial in Carmel, Indiana. Taking out a loan is the best way to tap into a retirement account without losing funds to taxes.
A hardship distribution or early withdrawal could be structured in a way to minimize the tax impact, though. Clark uses the example of a household in the midst of a low-income year. If they withdrew up to the standard tax deduction amount — which is $30,000 for married couples filing jointly in 2025 — they would only need to pay the 10% tax penalty.
“That wouldn’t be terrible,” Clark says.
Exceptions to the 10% Penalty
The IRS outlines circumstances in which a person can withdraw 401(k) funds early and not pay the 10% penalty, although regular income taxes may apply. They include:
— Death, disability or terminal illness of the plan participant
— Withdrawals to pay unreimbursed medical expenses over 7.5% of a person’s adjusted gross income
— Up to $5,000 per child for qualified birth or adoption expenses
— Up to $22,000 for economic losses sustained as a result of a federally declared disaster where the plan participant lives
— Up to $10,000 or 50% of an account balance, whichever is less, for victims of domestic abuse
— Up to $1,000 per year for personal or family emergency expenses
— Certain distributions to qualified military reservists who are called to active duty
There are two less well-known ways to tap into a 401(k) without penalty. The first applies to those who leave a job after age 55, or 50 in the case of certain public service workers. In these cases, workers are eligible to take penalty-free early distributions. However, this only applies to the 401(k) plan from the job they just left and not retirement accounts held by previous employers.
The other less common way to access penalty-free early withdrawals is by making a series of substantially equal periodic payments, commonly called SEPP. Also known as 72(t) distributions for the section of the law that allows them, SEPP is only an option after someone has left the job holding their 401(k) account, and it requires payments to be made at least annually.
“There are pros and cons,” Clark says. “It gives us access, but it’s an irrevocable decision. We need to be very certain that’s what we want to do.”
Consult with a financial professional before going this route.
[Related:How to Save in a 401(k) and IRA in the Same Year]
Early Withdrawals May Shortchange Retirement Plans
Income taxes and the 10% penalty are the short-term costs of a hardship distribution or early withdrawal. There are also long-term costs.
“Not only have you paid extra money in taxes, you’ve lost compound growth,” Policar says.
Compound growth refers to the process in which earnings are reinvested in an account and additional interest or gains are earned. However, when cash is withdrawn from a retirement account, workers miss out on this opportunity,
For instance, a 45-year-old who takes a $10,000 early withdrawal could pay $3,200 in income taxes and the tax penalty if they are in the 22% tax bracket. Over the course of 20 years, that withdrawal would also mean the worker has $22,000 less in their retirement fund at age 65, based on a 6% annual rate of return. As a result, the total cost of this $10,000 withdrawal would be $23,200.
For this reason, finance experts urge workers to use early withdrawals only as a last resort. “If you can find any other way to do it, you’re going to be better off in the long run,” Gildea says. “It’s so hard to catch up again.”
If you are worried about having money for emergencies, consider whether it makes sense to diversify your savings.
“It’s OK to save for retirement outside a retirement account,” Policar says. “Peel off a few dollars and put them in a brokerage account, high-yield savings account or CDs.”
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How Much Are 401(k) Early Withdrawal Costs originally appeared on usnews.com
Update 03/18/25: This story was published at an earlier date and has been updated with new information.
