A 401(k) is a powerful retirement saving tool. You won’t be taxed on your contributions or while your money grows, and the money you put in reduces your taxable income. But because of its tax advantages (and the fact that it’s meant to help people save for retirement), there are a few rules surrounding how and when you can take your money out of your 401(k).
Read on to learn more about the rules regarding when you can start taking withdrawals.
When can I take money out of my 401(k)?
During your working years, it may be possible to take a loan from your 401(k), depending on what your plan allows. Loans generally must be repaid with after-tax dollars within five years (with interest) and are typically capped at half of your savings up to $50,000 in a 12-month period. While this can be an option, it’s typically only something to consider as a last resort. 401(k) funds are meant for retirement. Not only do you have to pay the money back with after-tax dollars, but you are missing out on market growth of your invested dollars. Pulling money out along the way could impact your future returns.
You can withdraw money from your 401(k) as you wish, but doing so prior to age 59½ typically triggers a 10 percent penalty. That’s on top of income taxes unless you qualify for an exception. Once you turn 59½, you’re allowed to take money out of your 401(k) — technically known as a distribution — whenever you like, penalty-free. (Taxes will still apply.)
But just because you can tap your 401(k) funds starting at that age, the real question is, should you? Your 401(k) will likely be one of your essential sources of retirement income, so it’s important to have a financial plan that lays out how you’re going to draw down from it — especially if you’re planning to take money out early.
Are you on track for retirement?
See how much monthly retirement income you may have based on what you’re saving now.
Benefits of taking money out of your 401(k) earlier
Your 401(k) is likely a centerpiece of your retirement income plan. Taking distributions sooner rather than later, like in your early 60s, can have benefits.
It can make an early retirement possible
Depending on your financial situation, you may have the financial freedom to step out of the workforce by the time you’re 60. It’s your nest egg, and you’ve worked hard to build it by making regular contributions during your working years. 401(k) distributions, along with other sources of retirement income, can set the stage for this new phase of your financial life.
It can help you delay taking Social Security
You can’t begin claiming Social Security until age 62. Still, it can be beneficial to delay it. That’s because your monthly benefit will increase every year that you wait until age 70. Since Social Security pays guaranteed income that will last for as long as you live, a larger monthly benefit could pay off over time.
Drawbacks of tapping your 401(k) earlier
Retirement income generally has a lot of moving parts. Dipping into your 401(k) in your early 60s could have a ripple effect that impacts your overarching income plan.
[H3] You’ll be taxed on 401(k) distributions
Since traditional 401(k)s are funded with pretax dollars, distributions are taxed as ordinary income. No matter when you take money out of your 401(k) in retirement, it’s a good idea to do so in the context of other income sources — which may have different tax treatment. For instance, it might make sense to use a mix of 401(k) funds and Roth funds to manage your tax brackets in retirement.
You’ll miss out on tax-deferred growth
Because your money isn’t taxed as it grows in your 401(k), leaving your funds i in there gives them more time to grow and compound before you owe tax on them.
You will eventually be required to take money out of your 401(k)
If you decide not to tap your 401(k) early, there will come a time when you will be forced to start taking distributions. If you turn 72 in 2023, you must take required minimum distributions (RMDs) beginning at age 73. Just as you’ll owe penalties for taking money out of your 401(k) early, you’ll also be penalized if you fail to take RMDs and leave money in your 401(k) too long. In 2033, the RMD age will jump up to 75.
Ultimately, a solid plan for retirement will show you how to use your savings and other financial tools to live comfortably for the rest of your life. A financial advisor can help you build a strategy that allows you to generate reliable income for as long as you live.
This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation. All investments carry some level of risk including the potential loss of all money invested.
Want more? Get financial tips, tools, and more with our monthly newsletter.