If you’ve been thinking of withdrawing from your retirement account in a moment of financial stress, you’re not alone.

According to a recent report from Bank of America, 2.5% of participants borrowed from their 401(k) plans in the third quarter of 2024, and the average loan per participant was $9,100.

While you can withdraw money early from your 401(k) or traditional IRA, there’s a catch—usually a costly one. Between penalties, taxes, and missed growth opportunities, it’s worth knowing the rules before you dip in.

The good news? There are a few exceptions to help you avoid the penalties if you meet specific criteria. Let’s break it down.

What is an early withdrawal penalty?

Retirement accounts, like 401(k)s and IRAs, are designed for long-term savings—emphasis on long-term. The IRS sets rules to keep that money tucked away until you reach 59½ years old. If you withdraw funds from your retirement account before then, you may face a 10% early withdrawal penalty on top of the regular income taxes you owe on the money you take out.

For example, let’s say you withdraw $10,000 from your 401k. You’ll owe $1,000 (10% penalty) plus ordinary income taxes based on your tax bracket, which eats into the net amount of your 401k withdrawal.

So while it’s technically your money, Uncle Sam takes a bigger cut if you break into it early.

Exceptions to the 10% penalty

Before you resign yourself to paying penalties, some exceptions allow you to take money out early without that extra 10% fee. These rules vary slightly between 401(k)s and IRAs, so let’s look at each one.

Exceptions for 401(k) plans

• Separation from service. If you leave your job (voluntarily or involuntarily) in the year you turn 55 or later, you can withdraw funds penalty-free. This is sometimes called the “Rule of 55.”
• Qualified domestic relations order (QDRO). If you split retirement assets due to a divorce, the funds can be distributed penalty-free under a QDRO.
• Medical expenses. If your unreimbursed medical expenses exceed 7.5% of your adjusted gross income (AGI), you can withdraw funds to cover those costs without penalty.
• Disability or terminal illness. If you become permanently disabled or are diagnosed with a terminal illness, the penalty is waived.
• Death. If the account owner passes away, beneficiaries can access the funds without facing the 10% penalty.
• Military service. You may be eligible for penalty-free withdrawals if you’re called to active duty for at least 180 days.
• Birth or adoption expenses. You can withdraw up to $5,000 penalty-free for qualified birth or adoption expenses.
• Disaster recovery distribution. You can withdraw up to $22,000 to cover losses if you live in a federally declared disaster.
• Domestic abuse victim distribution. Victims of domestic abuse by a spouse or domestic partner can withdraw up to $10,000, or 50% of their account balance, whichever is less.
• Emergencies. You can make one distribution per calendar year to cover personal or family emergency expenses, but it’s capped at the lesser of $1,000 or your vested account balance.
• IRS levy. You won’t owe a penalty if the IRS levies your account to cover back taxes.

Exceptions for traditional IRA early withdrawals

• Higher education expenses. Need to pay for tuition, books, or required fees for yourself, your spouse, or dependents? You can withdraw IRA funds penalty-free.
• First-time home purchase. You can withdraw up to $10,000 from an IRA to buy or build a home if you (or your spouse) haven’t owned one in the past two years.
• Medical expenses. Similar to 401(k)s, you can withdraw funds for unreimbursed medical costs exceeding 7.5% of your AGI.
• Health insurance premiums. If you’re unemployed for 12 weeks or more, you can take funds to pay for health insurance premiums without the penalty.
• Disability or death. As with 401(k)s, the penalty is waived if you become disabled or pass the account to beneficiaries after your death.
• Substantially equal periodic payments (SEPP). This exception allows you to withdraw regularly over a set period, often based on life expectancy. Once you start, you’ll need to stick to the schedule for at least five years or until you turn 59½, whichever comes later.
• Birth or adoption expenses. You can withdraw up to $5,000 penalty-free for qualified birth or adoption expenses.
• Disaster recovery distribution. You can withdraw up to $22,000 to cover losses if you live in a federally declared disaster.
• Domestic abuse victim distribution. Victims of domestic abuse by a spouse or domestic partner can withdraw up to $10,000, or 50% of their account balance, whichever is less.
• Emergencies. You can make one distribution per calendar year to cover personal or family emergency expenses, but it’s capped at the lesser of $1,000 or your vested account balance.
• Military service. You may be eligible for penalty-free withdrawals if you’re called to active duty for at least 180 days.
• IRS levy. You won’t owe a penalty if the IRS levies your account to cover back taxes.

Why you should think twice before withdrawing early from your retirement account

Aside from penalties and taxes, an early distribution can derail your retirement savings because retirement accounts grow through compound interest—the snowball effect where interest earns more interest. Taking money out interrupts that growth.

Taking out money now may mean less savings when you retire.

Even though it may be tempting to draw on your nest egg during tough times, consider other options first, such as tapping your emergency fund or taking out a personal loan, a home equity loan, or a home equity line of credit (HELOC).

Another option? A 401(k) loan

Some 401(k) plans allow you to borrow from your own retirement plan and pay yourself interest. This might be a better option than an early distribution, but keep in mind that 401(k) loans come with potential pitfalls.

First, if you leave your job for any reason while you have an outstanding loan, you have a limited amount of time to repay the borrowed amount or roll it over into another eligible retirement plan. If you don’t, your former employer must report the loan to the IRS on a 1099 form as a “deemed distribution,” and you’ll owe income tax on the outstanding balance as if it were an early distribution.

Second, borrowing from your 401(k) can mean years of missed retirement savings. Some plans won’t allow you to contribute to your 401(k) while you have an outstanding loan. If it takes three years to repay the loan, that’s three years without adding to your retirement funds. You may also miss out on employer matching contributions during that time.

Are early withdrawals from your retirement account worth it?

Yes, you can withdraw money early from your retirement accounts, but there’s often a hefty price to pay. While exceptions exist for certain distributions, pulling funds early should be a last resort. Before you decide, weigh the pros and cons, and work with an advisor to explore options that won’t jeopardize your future security.If you need help making the decision, navigating withdrawal rules, or figuring out whether early withdrawal taxes apply, reach out to Countless.