Early 401(k) Withdrawals: Benefits, Risks and Alternatives

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published 27 June 2024

As a Kiplinger reader, you’re likely someone who manages their finances thoughtfully and has been saving for retirement in a tax-advantaged plan like a 401(k). You’ve also probably heard that taking cash out of your 401(k) before you’re 59½ is generally inadvisable, given the taxes and penalties on early withdrawals.

But even the most responsible of us can face a financial emergency and have thought about tapping into savings stashed in a 401(k). Maybe you have unexpected medical bills after an accident or hurricane damage to your home. Or maybe you need funds to pursue an exciting new opportunity, like buying a home, starting a business or going back to school.

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Taking a hardship withdrawal. Most 401(k) plans allow withdrawals in a period of dire financial need. This typically involves difficulties stemming from medical expenses, costs relating to the purchase of your principal residence, tuition and related educational fees or expenses, payments necessary to prevent eviction from or foreclosure on your principal residence, burial or funeral expenses, certain repair costs for your principal residence and any losses or expenses incurred by a federally designated disaster (such as a hurricane, wildfire or industrial accident). Your 401(k) website will have more information, including withdrawal amounts, terms and conditions.

Structuring periodic payments. Though less common, you can also elect to take a 72(t) distribution, also known as a substantially equal periodic payment, from your 401(k) plan. These can come in three forms: required minimum distributions (RMDs), fixed amortization or fixed annuitization. While you can leverage this option at any age, they are dependent on life expectancy factors, and you should work with your financial adviser and/or CPA to select the best method for you.

While the 10% early withdrawal penalty doesn’t apply in this case, these distributions would be subject to income tax. They also come with some drawbacks: You cannot take the full amount in a lump sum, have little flexibility once the initial terms are set and must continue with payments for either five years or until age 59½ (whichever comes first). Still, these can be useful for those who want to retire early.

Special circumstances. Outside of immediate hardship, there are other special situations that will allow you to draw on your 401(k) early without a penalty. Examples include disability, terminal illness or recently giving birth to or adopting a child. Similarly, if you need to make payments in the course of a divorce, you can access a lump sum without penalty (though it may be subject to income taxes depending on the terms of your qualified domestic relations order).

Drawing on home equity. If you own your home, establishing a home equity line of credit can allow you to cover your expenses or consolidate debt from other loans with a better interest rate (the current average for a home equity loan is around 9%). By borrowing against your home’s value, you can get through a financial rough patch and repay what you borrowed when you’re more financially stable. But there are many important considerations associated with drawing on home equity, and you should consult a qualified mortgage professional to learn more.

However, a word of caution: Loans and withdrawals from a life insurance policy reduce the policy’s cash value and death benefit and increase the chance that the policy may lapse. If the policy lapses, matures, is surrendered or becomes a modified endowment, the loan balance at such time would generally be viewed as distributed and taxable under the general rules for distributions of policy cash values. For variable life insurance policies, withdrawing from your policy’s cash value account can permanently reduce the value of your policy in the future, as you would lose out on the market return potential on the money that’s been withdrawn — meaning your beneficiaries may also receive less when the policy’s death benefit, which is the primary purpose of all life insurance, is paid out.

This article, which has been written by an outside source and is provided as a courtesy by Stephen B. Dunbar III, JD, CLU, Executive Vice President of the Georgia Alabama Gulf Coast Branch of Equitable Advisors, LLC, does not offer or constitute, and should not be relied upon, as financial, investment, tax, legal, mortgage/home equity loan advice. Your unique needs, goals and circumstances require the individualized attention of your own tax, legal, financial, and mortgage /home equity loan professionals whose advice and services will prevail over any information provided in this article. Equitable Advisors, LLC and its affiliates do not provide tax or legal advice or services Stephen B. Dunbar III offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN), offers investment advisory products and services through Equitable Advisors, LLC, an SEC-registered investment advisor, and offers annuity and insurance products through Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified. AGE-6603227.1 (05/24)(exp.05/26)

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Stephen Dunbar, Executive VP of Equitable, has built a thriving financial services practice where he empowers others to make informed decisions and take charge of their future. He and his team advise on over $3B in AUM and $1.5B in protection coverage. As a National Director of DEI for Equitable, Stephen acts as a change agent for the organization, creating a culture of diversity and inclusion. He earned a bachelor's in Finance from Rutgers and a J.D. from Stanford.