How to Take Money from Your 401k Before Age 59 ½ Without a Penalty
If you’ve ever thought about retiring early – say, before age 60 – you’ve likely thought about how you’re going to be able to create the cash flow you need and to make it last for the rest of your life.
The problem is, you’re not yet old enough to take any Social Security retirement benefits (those can’t start until at least age 62), and, if you’re like many people, most of your savings are tied up in things like a 401k or traditional IRA. And thus, you think you can’t access that money until age 59 ½ without having to pay a ten percent penalty on any withdrawals you make.
So what do you do? Is there a way to get to your retirement account money before age 59 ½ without having to pay that penalty?
Here are a couple of ways you may be able to do that.
First, we should mention that if you have some funds in what’s called a “non-qualified” account, one that didn’t give you preferential tax treatment when you put money in and are not tax-deferred, you may want to consider dipping into those accounts first. Depending on the types of assets you have in there, you may be able to withdraw these funds at the lower qualified dividend and capital gains tax rates, and there’s no penalty involved for doing so. In fact, if you’re a joint married filer with income up to about $109,000 in 2022, you’ll pay no federal tax on your qualified dividends and long-term capital gains.
If you don’t like that option, though, you may be able to take distributions from a traditional IRA or a qualified plan like a 401k from a previous employer using the IRS code section 72(t) rule. This allows retirement account holders to avoid the 10 percent penalty by taking a series of substantially equal periodic payments from their account based on their life expectancy. The payments do have to continue for at least five years or until the account holder reaches age 59 1/2, whichever is longer. You’ll still pay ordinary income taxes on the withdrawals, but no pre-age 59 ½ penalty.
This 72-t option may make sense, but it can get complicated, and you have to follow the rules exactly. If you mess it up anywhere along the line, you could wind up paying retroactive penalties on every payment you took. So don’t use this method without getting help from a qualified financial advisor who can keep track of it all.
Finally, here’s one method that very few people even knew existed. If you separate service from your employer during or after the year you turn age 55, the ten percent penalty tax on distributions from that employer’s retirement plans does not apply. And if you’re a public school or charity organization employee with a 403b, the same goes for you. As long as you’re at least age 55 during the year you sever employment, distributions from that employer’s plan (and ONLY that employer’s plan) are fully taxable, but they’re not penalized.
The bottom line here is that if you’ve been saving on a regular basis and you want to retire before age 59 ½, you probably have a few options for funding your retirement without having to shell out that 10 percent penalty tax on early retirement account distributions. But remember, the consequences of making a mistake can be costly, so it’s best to have one of our Lucia Capital Group advisors help you through the process to avoid any unwanted tax surprises.
We do this kind of thing every single day here at Lucia Capital Group. How can we help you the most? Just give us a call.
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.
No client or prospective client should assume that this information, or any component thereof, serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.
The information provided is based on current laws, which are subject to change at any time. Lucia Capital Group is not affiliated with or endorsed by the Social Security Administration or any government agency.
Social Security rules can be complex. For more information about Social Security benefits, visit the SSA website at www.ssa.gov, or call (800) 772-1213 to speak with an SSA representative.
IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.
Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.