Withdrawing 401k money penalty free prior to 59 1/2

[miamivice]

A common adage on here is that 401k accounts are more than just retirement accounts - they are tax advantaged accounts. Indeed, some posters have claimed that one can withdraw money from 401k penalty free prior to age 59.5, however, these posters never take the time to explain.

Can someone explain this to me? Let's say that I am not leaving my current job and we are talking about pretax dollars.

[HomeStretch]

One method is the “rule of 55” that won’t apply to you if you aren’t leaving your employer. If separated from one’s employer at age 55+, 401k distributions can be made without penalty from that employer’s 401k plan. Not all plans allow partial distributions. So one would have to take a full distribution, the portion needed would be a penalty-free taxable distribution and the remainder would need to be rolled over to avoid taxes into a tIRA or a current employer’s 401k plan.

There are limited hardship withdrawals, some penalty-free, under certain circumstances. They are usually specified in your plan. Here is a link to an IRS FAQ:
https://www.irs.gov/retirement-plans/re ... tributions

[runner3081]

Rule 72t

https://www.investopedia.com/terms/r/rule72t.asp

[whodidntante]

Roth IRA conversions, observing the 5-year rule.

[ERISA Stone]

One method is the “rule of 55” that won’t apply to you if you aren’t leaving your employer. If separated from one’s employer at age 55+, 401k distributions can be made without penalty from that employer’s 401k plan. Not all plans allow partial distributions. So one would have to take a full distribution, the portion needed would be a penalty-free taxable distribution and the remainder would need to be rolled over to avoid taxes into a tIRA or a current employer’s 401k plan.

There are limited hardship withdrawals, some penalty-free, under certain circumstances. They are usually specified in your plan. Here is a link to an IRS FAQ:
https://www.irs.gov/retirement-plans/re ... tributions

FYI - a plan can allow a participant to take part cash, part rollover as long as the total vested balance is distributed. This still meets the total distribution provision.

[Phineas J. Whoopee]

My 401(k) only provides for a one-time lump sum of the whole amount, or for a ten year period in which the first year is 10% of the value, second 11%, all the way up to the tenth year being 100% of whatever remains. Taking distributions from it at 55 would make no sense, at least in my situation.

One way to avoid the early-withdrawal excise tax of 10% is to roll the assets over into an IRA, if you're eligible to do so, then start a Substantially Equal Periodic Payment, SEPP, plan.

The website 72tnet.com has some good information.

Note for other posters, the previously recommended site, 72t.net, has ceased operations.

PJW

[terran]

Here's a good explanation of both the Roth conversion ladder and rule 72(t) methods: https://www.madfientist.com/how-to-acce ... nds-early/

[bankle]

This link may also be of help, listing various types of early distributions that are (and are not) possible for 401ks.

https://www.irs.gov/retirement-plans/pl ... tributions

[SchruteB&B]

Can someone explain this to me? Let's say that I am not leaving my current job and we are talking about pretax dollars.

Many of the posters are just ignoring this stipulation.

[lakpr]

If you are still employed with the same employer, the only way to access the 401k funds without penalty will be to take a loan and then periodically repay it. It is not exactly what the poster is looking to accomplish, but gets you access to the funds.

Of course the risk is that, if you leave the employer, you have until the next year October 15th to repay the entire loan.

[Spirit Rider]

Depending on the OP's 401k plan rules. Previous pre-tax rollover contributions and vested employer contributions could be eligible for in-service rollovers to an IRA prior to age 59 1/2.

Then the OP could setup a 72t SEPP plan with those assets. However, there are significant restrictions on distributions and the 10% early withdrawal penalty applies to all distributions made if you break the plan.

[remomnyc]

While still employed:
1. Borrow money from your 401k and pay it back.
2. If employer permits in-service rollover from a 401k to an IRA (if allowed, usually at age 55 or 59-1/2), roll to IRA and set up 72t payments from IRA or convert IRA to Roth and begin withdrawing principal penalty free from Roth after 5 years.
3. Stop contributing to the 401k and use the cash you would have contributed.

[Spirit Rider]

2. If employer permits in-service rollover from a 401k to an IRA (if allowed, usually at age 55 or 59-1/2)

I wouldn't say "usually".

Age 55 is the exception to the 10% early withdrawal penalty for pre-tax withdrawals after separation in or after the year you turn 55. Age 59 1/2 is when the the early withdrawal penalty is removed and when in-service rollovers of employee elective contributions are allowed by the IRS.

From the latest IRS compliance check, 62% of 401k plans allow the in-service withdrawal/rollover of rollover contributions and vested employer contributions prior to age 59 1/2.

Ascensus provides the most common 401k plan document. It allows the immediate in-service withdrawal/rollover of rollover contributions immediately and the in-service withdrawal/rollover of vested employer contributions two years after the contribution or immediately after five years of service. A significant majority of large 401k plans allow the immediate in-service withdrawal/rollover of rollover contributions immediately and the in-service withdrawal/rollover of vested employer contributions with <= 10 years of service.

[remomnyc]

2. If employer permits in-service rollover from a 401k to an IRA (if allowed, usually at age 55 or 59-1/2)

I wouldn't say "usually".

Age 55 is the exception to the 10% early withdrawal penalty for pre-tax withdrawals after separation in or after the year you turn 55. Age 59 1/2 is when the the early withdrawal penalty is removed and when in-service rollovers of employee elective contributions are allowed by the IRS.

From the latest IRS compliance check, 62% of 401k plans allow the in-service withdrawal/rollover of rollover contributions and vested employer contributions prior to age 59 1/2.

Ascensus provides the most common 401k plan document. It allows the immediate in-service withdrawal/rollover of rollover contributions immediately and the in-service withdrawal/rollover of vested employer contributions two years after the contribution or immediately after five years of service. A significant majority of large 401k plans allow the immediate in-service withdrawal/rollover of rollover contributions immediately and the in-service withdrawal/rollover of vested employer contributions with <= 10 years of service.

Thanks, Spirit Rider. I conflated the typical in-service rollover age of 59-1/2 with the ages for penalty-free withdrawals after severing service.

[Spirit Rider]

That's ok, this still leaves many 401k plans that don't offer the in-service withdrawal/rollover of vested employer contributions prior to age 59 1/2.

I just wanted the OP to check out what if any in-service withdrawal/rollover options their plan actually allowed prior to age 59 1/2.

[aristotelian]

Why would you want to withdraw from your 401k while working? Setting aside the wisdom of drawing down investments, you would also be paying tax at your marginal rate, defeating the purpose of having saved pre-tax. If that is your plan, you are indeed better off saving in taxable since the gains will be taxed at a lower rate.

[JoMoney]

The withdrawal options available are dependent on your plan's rules. You will need to to consult them.
My employers plan will allow me to take a "loan" that is penalty free (but requires paying back while with the employer).
I can withdraw something close to 80% of my 401k for various "hardship" reasons. Whether or not the hardship will incur a early withdrawal penalty depends on if it fits certain IRS reasons.
I also have the option to withdraw or roll-over to an IRA any after-tax contributions, and any employer contributions. If this money is rolled into an IRA I could use a SEPP 72(t) payment schedule to receive the money without penalty, or could use the Roth IRA ladder method (provided I could wait 5 years).

[fujiters]

Why would you want to withdraw from your 401k while working? Setting aside the wisdom of drawing down investments, you would also be paying tax at your marginal rate, defeating the purpose of having saved pre-tax. If that is your plan, you are indeed better off saving in taxable since the gains will be taxed at a lower rate.

This topic often comes up in the context of "how do I prioritize investments if I intend to help my children pay for college?" People often recommend maxing out 401k before considering 529 or taxable. But if you are 50 and your children start college and you don't have enough to retire, how do you use all that money you stuffed into your 401k to help pay for college? In that case, I think the answer is that you use your larger than otherwise 401k balance to justify decreasing 401k contributions to cash flow college expenses when the time comes. Taking a 401k loan at that point may also make sense depending on your continued employment prospects during the repayment period.

[JoMoney]

... if you are 50 and your children start college and you don't have enough to retire, how do you use all that money you stuffed into your 401k to help pay for college?...

My answer would be that you don't use your retirement to pay for college. There are lots of ways to pay for college, preferably through scholarships and grants... maybe it takes a bit longer and the student has to work to help pay for it, maybe take out loans. You don't have alternative options to fund your retirement.