Can I Legally Withdraw My 401(k) Without Quitting My Job?

When you quit your job or are laid off or terminated, you might want to use your 401(k) money to pay your bills while you're looking for work. There are times when you also might want to take out money while you're still working. While this might seem necessary in certain circumstances, it might be more costly than you think, and in most cases, you might be legally prohibited from doing this.

When you're under 59 1/2 years old, the only guaranteed way to access your 401(k) funds legally is to leave your job – but don't jump ship just yet. Depending on the terms of your plan, you might be able to take a hardship distribution or borrow from your 401(k). However, the Internal Revenue Service leaves those options to the discretion of each 401(k) plan, so you might be out of luck.

Your 401(k) plan may permit withdrawals if you have an immediate and heavy financial need that you can't satisfy with other resources. Examples include mortgage or rent payments to avoid eviction, costs of medical care or a home purchase. Make sure you work with a tax professional before you claim a hardship – if it's not allowed, you might end up in hot water with the IRS.

Usually, according to the IRS, you can't take out more than you've contributed to the plan, not including contributions your employer made on your behalf or the earnings on your contributions.

With a traditional 401(k), you don't pay taxes until you withdraw your money. If you have a Roth 401(k), you pay taxes at the time you contribute and then withdraw your money tax- and penalty-free after age 59 1/2 years old. How and when you can take early withdrawals and the penalties and taxes also vary, explains Charles Schwab.

Though a hardship withdrawal might sound justifiable, it's not going to help you come tax time. Like all other withdrawals, you're still on the hook for any income taxes due on the distribution.

Plus, unless your situation qualifies for an exception, hardship withdrawals are hit with the ​10 percent​ additional tax penalty when you're under 59 1/2 years old. Exceptions that will get you out of the penalty (but not regular income taxes) include suffering a permanent disability, medical expenses exceeding ​10 percent​ of your adjusted gross income or the IRS levying on your 401(k) plan.

Your 401(k) plan also might permit you to borrow money from your account – and you won't need a financial hardship to do so. The IRS caps the amount you can borrow at ​$50,000​ or half your vested account balance – whichever is smaller – and repayments can't exceed ​five years​ unless you're using the loan to buy a primary residence. Though the loans charge interest, that money goes back into your 401(k) plan, which may help make up for the investment gains you'll lose.

If you repay your loan as agreed, the amounts borrowed and repaid won't affect your taxes at all because you're essentially borrowing your own money. However, if you default on your loan, the tax consequences can be nasty since the IRS will consider it an early distribution.

Any unpaid balance on the loan counts as taxable income in the year of default and, when you're under 59 1/2, also gets hit with the ​10 percent​ early withdrawal penalty. For example, if you default with ​$3,500​ left on your loan, you pay income taxes on ​$3,500​, plus a ​$350​ penalty.