Rules for Withdrawing From a 401(k) for Long-Term Disability

According to the IRS, 401(k)s are tax-favored, employer-sponsored accounts that you can fund with pre-tax or after-tax wages to prepare for retirement. Both employers and employees can contribute these funds.

Because of the tax advantages that 401(k)s are structured to offer, withdrawing money from them may be considered a tax event. Not only may you be required to pay regular taxes on the distributions, but you may also be forced to pay a penalty for early withdrawal. However, there may be some exceptions, however, such as long-term disability.

Roth 401(k)s usually don’t attract any taxes as long as you make qualified distributions at the designated age and meet the ​five-year​ requirement. However, traditional 401(k)s require you to pay taxes at ordinary rates. That is because the former is funded by after-tax dollars, while the other is funded by pre-tax dollars.

Based on the current IRS rules, you can withdraw money from your 401(k) account without penalty if you are at least ​59.5 years​ old. Any withdrawal that you make earlier than that may attract a ​10 percent​ penalty fee for early withdrawal. The penalty would be what you pay on top of any taxes that are due on your distributions.

However, there are several exceptions for cashing out a 401(k), and one of those exceptions is when you experience a long-term disability.

If you meet the IRS' criteria for disability, then the 401(k) disability withdrawal rules, which are usually the early withdrawal rules, will apply to your situation. You must be totally and permanently disabled physically or mentally, and your disability must prevent you from engaging in substantial gainful activity that would otherwise have enabled you to continue taking care of yourself and any dependents. Also, a qualified physician must examine you and certify that you are disabled and your condition will last for at least a year.

Usually, the instructions for how to withdraw your 401(k) funds early after becoming disabled will be included on your plan document. Also, the document will lay out the criteria you must meet to be considered disabled. It is best to contact your Human Resources department and request help on the matter.

Remember that as long as you qualify as having a long-term disability, you don’t have to wait until you are 59.5 years old nor do you have to pay the early withdrawal penalty. However, you must report your distribution as income, possibly resulting in taxation if the money is in a non-Roth account.

If you prefer to withdraw money from your 401(k) without having to mention your disability, you could explore other options.

The IRS permits a hardship withdrawal based on your immediate and financial needs. Also, the amount will be limited to what is necessary to satisfy that need. The withdrawal is subject to income taxes if it is a non-Roth account withdrawal and may be subject to an early withdrawal penalty.

Any medical expenses you incur to deal with a long-term disability will be catered to by what you withdraw from your 401(k). Also, you can pay bills related to your primary residence, tuition for your dependents or spouse, and funeral expenses for family members.

However, you must have explored other options. In addition, you can only withdraw the funds from your contributions or those of your employer and not the investment earnings.

If you meet the IRS criteria, you can apply for and receive a plan loan. Typically, these loans allow you to get ​50 percent​ of your vested amount up to ​$50,000​, whichever is smaller. They are not taxable as long as you meet the loan conditions. You must repay them within ​five years​ by making at least quarterly payments.

If you default on the loan or leave the company, you will pay any taxes due at ordinary rates. In addition, you will likely pay the ​10 percent​ early withdrawal penalty.