A 401(k) plan is designed to help you squirrel away money for retirement, but that doesn't mean you must wait until your golden years to tap your cash. All of the money you stash in your 401(k) is yours to withdraw whenever you want, even if you are still working or below retirement age. But you should think twice before raiding your account early because it can be costly in short-term and the long run.
401(k) Withdrawal Basics
The cash to funnel into your 401(k) comes straight out of your paycheck, so you don't pay income taxes on it up front. Instead, you have to include the money you withdraw in your taxable income. Because your income tax rates may be higher while you are working than when you are retired, tapping into your account early can result in paying more taxes. By draining funds from your account before retirement, you'll also lose out on any tax-deferred investment gains that cash may produce.
Early Withdrawal Penalty
Although you can tap your 401(k) whenever you want to, withdrawals you make before the age of 59 1/2 are considered early distributions. The Internal Revenue Service hits you with a 10 percent penalty on early withdrawals, along with regular income taxes. You can dip into your account early without penalty in special cases, such as if you are disabled, inherit an account from someone else or have certain tax-deductible medical expenses.
Some employers offer contribution-matching plans, where they put funds into the account on your behalf for each dollar you save. If your employer transfers cash into your 401(k), you may not be allowed to withdraw all of it right away. Instead, you might have to wait until you are vested in the funds, which can take a few years depending on the details of your plan.
It is possible to access the cash in your 401(k) without making a permanent withdrawal, using a 401(k) loan. According to the IRS, a 401(k) loan usually lets you take up to $50,000 out of your account tax-free, as long as you repay the money in five years. Any interest you pay on the loan goes back into your account, which can make it less costly than a normal loan.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.