When Can I Draw From My 401k

When Can I Draw From My 401k

Hey man, I’ve been there.  I don’t recall exactly when it was, maybe around 8-9 years ago.  Obviously I was in some kind of a financial pinch.  I think for one reason or another the amount of money coming into my household had dropped fairly significantly.  And it looked like it was going to be that way for the next 6 + months.  Daddy had bills to pay and the well was running dry.  The savings account was about tapped out and I was getting close to desperation mode.  So naturally my mind was asking, when can I draw from my 401k?

I did wind up taking out about $10,000 from my 401k and while it did help me in the short term, it bit me in the a** soon after.  Plus the fact I had $10k less towards my hard earned retirement.  Which is something many of us think about doing when times get tough.  We do something that either helps us or we want to do right now and pay for it later in one fashion or another.  Maybe you find yourself in a cash pinch now or maybe you’ve been thinking about getting something you want but don’t have the immediate cash for it.  You could use your 401k for that right?  Well, you probably could, depends on your employer.  The bigger questions is should you.  Let’s discuss when can I draw from my 401k.

401k VS. IRA

So it’s probably worth doing a quick review of an IRA and a 401k.  The reason being is if you decide to withdraw from either of these accounts there are different repercussions.  So here we go:

401k – a 401k plan is a qualified employer sponsored retirement plan.  If you have access to an employer sponsored plan you should participate in it, especially if your company offers matching contributions.  If you don’t it’s like losing free money.  All money you put into your 401k plan is pre-taxed.  This means you don’t get taxed on it the year you earned it so there’s another good reason to leverage your company sponsored 401k plan.

IRA – An IRA is another way to save for retirement and do some investing.  Anyone can contribute to an IRA plan as long as they are under the age of 70 1/2.  An IRA is a good retirement vehicle and also offers tax deferred growth on your investments.  An IRA might also have tax deductible contributions which is great for people that don’t have an employer sponsored plan.

When Can You Draw From your 401k With No Penalty

The short answer to the big question is you can withdraw from either your 401k or an IRA after the age of 59 1/2 with no penalty.  The reason being of course is because this money is set up pre-tax in order to help folks save for retirement.  The goal is to put money into these accounts for when we need them in the future, basically when we aren’t working any more.  So think of both the 401k plan and an IRA as a way to help you save for retirement.  They aren’t designed to be savings plans like at your bank that you can put money in and take it out anytime you want.  Don’t think of it that way.Taking From Your 401k or IRA – With A Penalty

While many people put money into an IRA or a 401k to save for retirement, lots of people also withdraw from these accounts for lots of reasons.  Some of the reasons include loss of a job, medical bills or issues, major house upgrades needed and general life hardships.  If you take a distribution from your 401k plan or your IRA before the age of 59 1/2 you are assessed a 10% penalty tax in addition to any other taxes you owe.  That’s a chunk of change.  If you want to take out $10,000 that winds up being $9,000 up front plus the taxes which sucks.  But if you desperately need the money that 10% penalty number isn’t going to slow you down much.

Withdraw or Taking A Loan Out

With a 401k you can only borrow against your own 401k if your employer allows it.  Each employer is different and will have different terms.  Some employers don’t even allow it but many do.  The last I was aware of the biggest loan you can take out from a 401k allowed by the IRS was $50,000 or half of your 401k.  That may have changed as tax laws seem to change almost yearly.  Normally you pay back the principal and some interest which is a little above the prime rate.  Normally you start paying yourself back right away and it goes up to 5 years.

With an IRA account you can take some of the money out with no penalty for several reasons and will only pay the income tax for the IRA payout.  These reasons are for education (like if you were finishing your bachelors or going to grad school), a first time home purchase (up to $10,000) or medical expenses (if your incurred medical expenses are greater than 10% of your adjusted gross income that year).  These are the 3 primary reasons for being able to take out money from your IRA without a penalty.

The Bottom Line

Hopefully we’ve covered from a high level enough information regarding when can I draw from my 401k – and IRA – to help answer the question broadly.  If you have both an IRA account and a 401k plan it’s possible to access that money for different reasons.  For something like a short term emergency like a car that dies and you need another one right away taking a 401k loan out is probably your best option.  You can start paying yourself back right away and you won’t incur a penalty (just interest).  For further education, medical expenses, or buying a house for the first time tapping into your IRA is probably the better choice and there’s no penalty (just taxes to pay).

The #1 option is to not withdraw any money at all if you can help it.  The ability to leave that money in the account to continue to build and compound over the long haul is going to help you so much towards your retirement.  Sometimes life gets in the way and we can’t always do that of course but do your best to set it and leave it.

In good financial health,

Mat A.