Cashing out a retirement account early is legal, but if you’re under 59½ you’ll pay a 10% federal penalty on top of ordinary income tax, a combination that routinely eats a third or more of the withdrawal.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions Federal law does waive that 10% for a specific list of life events, and SECURE 2.0 added several new ones starting in 2024. The rules aren’t identical for IRAs and 401(k)s, though, and treating them as interchangeable is one of the more expensive mistakes people make with this money.
What the Withdrawal Actually Costs
Every early distribution from a traditional IRA, 401(k), 403(b), or similar tax-deferred plan gets added to your taxable income for the year. On top of that income tax, you owe a separate 10% additional tax on the taxable portion of the withdrawal.2Internal Revenue Service. Substantially Equal Periodic Payments
Run the numbers on a $50,000 withdrawal at age 45. If your marginal federal rate is 22%, the income tax is $11,000. The penalty adds another $5,000. State income tax may pile on top. Before the money reaches your account, roughly a third of it is gone, and you’ve permanently pulled that balance out of the tax-advantaged compounding it was doing inside the plan.
There’s a withholding detail that surprises people. When you take an early distribution directly from a 401(k) or 403(b), the plan is required to withhold 20% for federal income tax before sending you anything.3Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules IRA distributions default to 10% withholding, which you can adjust. Withholding is just a prepayment; if your actual tax bill plus penalty exceeds what was withheld, the balance is due at filing.
So on that $50,000 401(k) withdrawal: the plan sends you $40,000 after withholding $10,000. At tax time you owe $11,000 in income tax (of which $10,000 was already paid) plus the $5,000 penalty. Net in your pocket, ignoring state tax, is about $34,000.
Roth Accounts Work Differently
A Roth IRA lets you withdraw your own contributions at any time, at any age, with no tax and no penalty. Distributions come out of contributions first, so as long as you stay under your total lifetime contributions, you owe nothing.4Internal Revenue Service. Retirement Plans FAQs Regarding IRAs Distributions (Withdrawals) Earnings are different: pull earnings before age 59½ and before the account has been open five years, and they face both income tax and the 10% penalty.
Roth 401(k) distributions don’t get the same contribution-first treatment. They’re generally prorated between contributions and earnings, so you can’t selectively withdraw just what you put in.
Exceptions That Waive the 10% Penalty
Congress has written a list of situations where the 10% penalty doesn’t apply. The distribution is still taxed as ordinary income (unless it’s from a Roth contribution), but the extra 10% goes away. Which exceptions you can use depends on the type of account, and the IRS keeps a chart mapping each one to eligible plans.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
Available for Both IRAs and Employer Plans
- Total and permanent disability, certified by a physician as a condition preventing substantial gainful activity and expected to last indefinitely or result in death.5Internal Revenue Service. Retirement Topics – Disability
- Unreimbursed medical expenses above 7.5% of your adjusted gross income for the year.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
- Birth or adoption expenses, up to $5,000 per parent per child, with an option to repay the amount later.
- An IRS levy against your retirement account to satisfy a tax debt.
- Distributions to a beneficiary after the account holder’s death, regardless of the beneficiary’s age.
IRA-Only Exceptions
Two commonly cited exceptions apply only to IRAs, not to 401(k)s or 403(b)s. If your money is in an employer plan, rolling it to an IRA first is sometimes necessary to use these.
First-time homebuyer. You can pull up to $10,000 from an IRA over your lifetime to buy, build, or rebuild a first home, penalty-free. The funds have to be used within 120 days. “First-time” is loose: you qualify if you haven’t owned a principal residence in the previous two years.
Higher education. IRA distributions used for qualified higher education expenses for you, your spouse, children, or grandchildren, including tuition, fees, books, and room and board, avoid the penalty.6Internal Revenue Service. Publication 970 – Tax Benefits for Education The penalty-free amount drops by any tax-free educational assistance the student received.
Employer-Plan-Only Exceptions
The Rule of 55. If you leave your job during or after the calendar year you turn 55, you can take penalty-free distributions from that employer’s 401(k) or 403(b).3Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules Public safety employees get the same treatment starting at age 50.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions The exception only covers the plan at the employer you separated from, and it does not apply to IRAs. If you already rolled the 401(k) into an IRA, that money no longer qualifies.
Hardship withdrawals are not automatically exempt. A 401(k) hardship withdrawal lets you access elective deferrals for an immediate and heavy financial need, but the 10% penalty still applies unless you separately qualify under one of the exceptions above. The money is taxed as ordinary income, and you can’t repay it to the plan.7Internal Revenue Service. Hardships, Early Withdrawals and Loans
Newer Exceptions Under SECURE 2.0
Congress added several penalty-free categories in the SECURE 2.0 Act of 2022, most of them phasing in starting in 2024. These apply to both IRAs and employer plans unless noted.
Emergency personal expenses. One self-certified withdrawal per calendar year, up to $1,000, for unforeseeable or immediate financial needs. You have three years to repay, and you can’t take another emergency withdrawal during that window unless you’ve paid the previous one back.
Domestic abuse. A survivor of abuse by a spouse or domestic partner can take a self-certified penalty-free distribution within one year of the abuse. The cap for 2026 is $10,500, indexed for inflation from the original $10,000.8Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted Three years to repay.
Terminal illness. If a physician certifies a condition reasonably expected to result in death within 84 months, you can take any amount penalty-free. Three years to repay if your condition improves.
Federally declared disasters. Up to $22,000 across all your retirement accounts, spread across three tax years if you choose, with three years to repay. If you repay within that window, you can amend prior returns to recover the taxes you paid on the distribution.9Internal Revenue Service. Disaster Relief FAQs – Retirement Plans and IRAs Under the SECURE 2.0 Act of 2022
Substantially Equal Periodic Payments
If nothing on the exception list fits, IRC Section 72(t)(2)(A)(iv) allows a structured workaround. You commit to a series of substantially equal periodic payments (a SEPP or 72(t) plan) calculated from your life expectancy, and the 10% penalty is waived.2Internal Revenue Service. Substantially Equal Periodic Payments This works for both IRAs and employer plans.
The commitment is real. Payments must continue for at least five years or until you reach 59½, whichever comes later. Start at 52 and you’re locked in until 59½ (seven and a half years). Start at 57 and you’re locked in for five. If you modify the schedule or take extra distributions before the period ends, the IRS retroactively applies the 10% penalty to every distribution taken since the SEPP began, plus interest.
Borrowing From a 401(k) Instead
If your employer’s plan allows loans, borrowing avoids both the tax and the penalty entirely because a loan isn’t a distribution. You can borrow up to the lesser of $50,000 or 50% of your vested balance. General-purpose loans have to be repaid in substantially equal installments, at least quarterly, within five years. Primary-residence loans can run longer.10Internal Revenue Service. Retirement Plans FAQs Regarding Loans
The trap is leaving your job. Any unpaid balance is treated as a distribution, taxed as income and hit with the 10% penalty if you’re under 59½.11Internal Revenue Service. Retirement Topics – Plan Loans You can head that off by rolling the unpaid balance into an IRA or another eligible plan by the due date of your tax return, extensions included, but that requires having the cash to fund the rollover.
Claiming an Exception on Your Return
Your plan administrator or IRA custodian sends you a Form 1099-R in January showing the gross amount, the taxable amount, and any tax withheld. You report the distribution on Form 1040.
To claim a penalty exception, file Form 5329 with your return and enter the exception number that matches your reason.12Internal Revenue Service. Form 5329 – Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts Skip the form and the IRS will assume you owe the penalty and bill you. Form 5329 is due with your return by the standard filing deadline, including extensions.13Internal Revenue Service. Instructions for Form 5329 If you’re not otherwise required to file, you still have to submit Form 5329 on its own.
Keep records that back up the exception. Itemized medical bills and explanations of benefits for medical exceptions. Enrollment and tuition records for education. Adoption decrees, physician certifications, closing documents for a first home. The IRS generally has three years to audit, and clean documentation resolves most questions quickly.