Early Retirement Withdrawals: Tax Penalties & Exceptions

Withdrawing money from your retirement savings before retirement age can lead to significant tax penalties, yet some people find it necessary in tough financial times. According to a Betterment at Work survey released in late 2023, 30% of workers accessed their retirement accounts due to economic instability. At the same time, Americans added $50 billion in new credit card debt, pushing the total to a record high of $1.13 trillion, based on data from the Federal Reserve Bank of New York. However, even with growing debt, tapping into retirement savings before retirement may not be the best option.

What are the Penalties for an Early Distribution from an IRA or 401(k)?

Not only will you be on the hook for taxes if you withdraw money from your 401(k) or traditional IRA before you retire, but you’ll also pay a 10% penalty for taking a premature distribution—that is, withdrawing money before attaining age 59 ½.  

Premature distributions from a Roth IRA incur the early withdrawal penalty only if earnings (not principal contributions) are withdrawn before age 59 ½. 

For SIMPLE IRAs, the early withdrawal penalty is 25% within the first two years of opening the account. After that, the penalty drops to the standard 10%. 

Are There Exceptions to These Early Distribution Penalties?

The IRS does recognize certain financial hardships – with proper documentation, of course.  

For IRAs, the early withdrawal penalty may be waived for the following reasons: 

• First-home purchase, up to a $10,000 gross distribution 

• Unreimbursed medical expenses (more than 7.5% of your adjusted gross income) for you, your spouse, or your dependents 
• College tuition expenses for you, your spouse, your children, or grandchildren 
• Permanent disability 
• Death—your beneficiaries will not have to pay the early withdrawal penalty upon cashing out, even if they are under age 59 ½  
• Paying back taxes via a forced IRA withdrawal after a levy has been put on the IRA 

• Medical insurance premium payments if you’ve been unemployed for longer than 12 weeks  

The plan document governs exceptions to the early withdrawal penalty for 401 (k) plans. If you need to take an early distribution, contact your employer or refer to your plan’s Summary Plan Description for more information. 

Should You Ever Take an Early Distribution With a Penalty?

The early withdrawal penalty discourages people from tapping into money intended for retirement. Your 401(k) or IRA is not a bank account, and taking a premature distribution should be viewed as an absolute last resort. (But sometimes, it’s unavoidable.) 

Additionally, if you’re under age 59 ½ and still working, your employer may require you to take a 401(k) loan before you can take a distribution. 

Because the penalty for an early distribution is so significant, you shouldn’t take one without professional advice. You may be able to avoid the penalty or find a better approach for solving the challenge you want the early distribution to solve. 

To get in touch, you can find an advisor in your area or fill out this form to request a no-cost, no-obligation advisor conversation.