How much you should withdraw from your 401k depends on the reason you’re taking money out. If you’re retired and living off the account, a common starting point is 4 percent of the balance in year one, adjusted for inflation each year after. If you’re 73 or older, the IRS sets a minimum you must take. If you’re pulling money out early or in a hardship, the right number is the amount you actually need grossed up to cover the taxes and penalties that will be withheld before the check reaches you.
The 4 Percent Starting Point for Retirees
Financial planner William Bengen’s research showed that a retiree who withdrew 4 percent of their portfolio in year one, then adjusted that dollar amount for inflation each year after, had a high probability of not running out of money over 30 years. It is still the most widely referenced starting point.
The math is simple. Multiply your balance on the day you retire by 0.04. A $500,000 balance produces a $20,000 first-year withdrawal. A $750,000 balance produces $30,000. In year two you don’t recalculate the percentage. You take last year’s dollar amount and raise it by that year’s inflation. If inflation ran 3 percent, your $20,000 becomes $20,600. Purchasing power stays roughly steady without forcing you to sell more shares after a bad market year.
The rule has a real vulnerability: sequence-of-returns risk. A sharp market drop in your first few years of retirement means you’re selling shares at depressed prices, and those shares never recover. The 4 percent figure was designed to survive the worst historical sequences, but it assumes roughly a 60/40 stock-to-bond allocation and a tax-advantaged account. If your retirement will last longer than 30 years, or you’re drawing from a taxable account, a lower starting rate is more appropriate.
Required Minimums After Age 73
Once you hit a certain age, the IRS stops letting you leave money in a traditional 401k indefinitely. You must begin required minimum distributions (RMDs) at 73 if you were born between 1951 and 1959, or at 75 if you were born in 1960 or later.
The amount is calculated by dividing your account balance as of December 31 of the prior year by a life expectancy factor from the IRS Uniform Lifetime Table. At age 73, the factor is 26.5. A retiree with a $400,000 year-end balance divides $400,000 by 26.5 and owes about $15,094. The factor shrinks each year, so the required percentage of your balance rises with age even if the balance stays flat. Redo the calculation annually.
If your spouse is more than ten years younger and is your sole beneficiary, use the Joint Life and Last Survivor Table instead, which gives a larger divisor and a smaller required withdrawal.
Missing an RMD is expensive. The IRS imposes a 25 percent excise tax on the amount you should have taken. That drops to 10 percent if you correct the shortfall within a two-year window. If the miss was a genuine mistake, file Form 5329 with a written explanation; the IRS can waive the penalty entirely.
One exception: if you’re past RMD age but still working, you can delay distributions from your current employer’s 401k until the year you actually retire. This does not apply if you own 5 percent or more of the business, and it doesn’t help with 401k accounts from previous jobs or with traditional IRAs.
Roth accounts in employer plans are no longer subject to RMDs starting in 2024. If you have Roth 401k money, you’re not forced to touch it on the IRS’s schedule.
Traditional vs. Roth Changes What You Keep
Traditional 401k contributions went in pre-tax, so every dollar you withdraw counts as ordinary income at your current rate. Roth 401k contributions went in after-tax, and qualified distributions come out entirely tax-free.
For a Roth 401k withdrawal to qualify, two things must be true: at least five years have passed since your first Roth contribution to the plan, and you’re at least 59½, disabled, or the distribution is going to a beneficiary after your death. Fall short of either and the earnings portion is taxed as income and may face the 10 percent early withdrawal penalty.
If you hold both traditional and Roth balances, drawing from the traditional first while letting the Roth grow is often the better sequence. The Roth compounds without creating taxable income, and nothing forces you to take it out.
Gross Up for Taxes and Penalties Before You Request an Amount
The amount you request is not the amount you receive. When you take a distribution eligible for rollover, the plan administrator must withhold 20 percent for federal income tax and send it to the IRS. A $20,000 withdrawal produces a $16,000 check. The only way to sidestep that withholding is a direct rollover to another eligible plan or IRA.
If you’re under 59½, the IRS adds a 10 percent early withdrawal tax on top of the income tax. Between the mandatory 20 percent withholding and the 10 percent penalty, you can lose 30 percent or more of the gross before state tax touches it.
When you need a specific amount of cash, work backward. Divide the net amount you need by one minus your combined tax and penalty rate. If you need $10,000 and expect a combined 30 percent hit, divide $10,000 by 0.70 to get roughly $14,286. Request that gross amount, and after withholding and penalties you’ll have your $10,000. Skipping this step is one of the most common mistakes people make, and it leaves them short of the amount they took the withdrawal for in the first place.
State Taxes Add to the Bite
Most states also tax 401k distributions as ordinary income. State rates on retirement income run from zero in no-income-tax states to over 13 percent in the top brackets of high-tax states. Some states exempt part of retirement income based on age or the source of the distribution, but the rules vary widely.
Factor your state’s rate into the gross-up calculation. A retiree over 59½ in a state with a 5 percent income tax rate faces an effective combined federal-and-state rate around 25 percent or more on traditional 401k distributions, depending on total taxable income for the year.
Hardship Withdrawals Are Capped at Your Need
If you’re still employed and under 59½, a hardship withdrawal may be your only path to your 401k. The IRS caps the distribution at the amount needed to cover your immediate financial need, and no more. If you need $10,000 for a medical bill, you get $10,000 for that bill.
You can add enough to cover the federal, state, and local taxes on the distribution itself. If a $10,000 medical bill will generate $3,000 in taxes, you may withdraw $13,000. Without that adjustment, the tax hit would leave you short of the money that justified the withdrawal.
Not every problem qualifies. Under IRS safe harbor rules, these expenses are automatically treated as meeting the “immediate and heavy financial need” test:
- Unreimbursed medical expenses for you, your spouse, dependents, or plan beneficiary
- Costs directly tied to buying your principal residence, excluding mortgage payments
- Tuition, fees, and room and board for the next 12 months of postsecondary education for you or your family
- Payments needed to prevent eviction or foreclosure on your principal residence
- Funeral expenses for you, your spouse, children, dependents, or beneficiary
- Certain expenses to repair damage to your principal residence
You also need to show you couldn’t reasonably get the money elsewhere, such as through insurance, other assets, or a plan loan. Administrators verify this with medical bills, eviction notices, tuition invoices, and similar documentation.
One limit worth knowing: hardship distributions generally come from your elective deferrals, employer matching contributions, and employer profit-sharing contributions. Investment earnings on your elective deferrals are typically not available.
When the 10 Percent Penalty Doesn’t Apply
Several exceptions let you avoid the 10 percent early withdrawal penalty, which changes how much you actually keep.
Rule of 55
If you leave your job during or after the year you turn 55, you can withdraw from that employer’s 401k plan without the penalty. This applies only to the plan held by the employer you’re leaving, not to 401k accounts from earlier jobs and not to IRAs. Qualifying public safety employees and certain federal law enforcement officers get age 50 instead.
Substantially Equal Periodic Payments
Under IRC Section 72(t), you can avoid the penalty at any age by setting up a series of substantially equal periodic payments based on your life expectancy. The IRS allows three calculation methods: required minimum distribution, fixed amortization, and fixed annuitization.
The catch is rigidity. Once you start, you cannot change the schedule until the later of five years or the date you turn 59½. You also cannot add money or take any distributions outside the scheduled payments. Modifying the schedule early triggers a retroactive 10 percent penalty on every payment already taken.
Other Exceptions
The penalty also doesn’t apply to distributions after total and permanent disability, distributions to a beneficiary after the account owner’s death, or payments under a qualified domestic relations order in a divorce. Medical expenses over 7.5 percent of your adjusted gross income qualify, as do distributions to reservists called to active duty for at least 180 days.
A 401k Loan Can Change the Math
Before withdrawing, check whether your plan allows loans. A 401k loan lets you borrow from your own balance and repay yourself with interest. No income tax, no penalty, as long as you follow the rules.
The maximum is the lesser of $50,000 or 50 percent of your vested account balance. If 50 percent of your vested balance is under $10,000, some plans let you borrow up to $10,000, though plans aren’t required to offer that.
Repayment must happen within five years with at least quarterly payments, unless the loan is used to buy your primary residence, which gets a longer window. The plan sets the rate, and interest goes back into your own account.
The risk is job loss. If you leave your employer with a balance outstanding and can’t repay, the remainder is treated as a taxable distribution, with the 10 percent penalty on top if you’re under 59½. You can avoid that by rolling the outstanding balance into an IRA or another eligible plan by the tax filing deadline for that year.
Inherited 401k Rules Set the Amount for You
If you’ve inherited a 401k, how much and when you must withdraw depends on your relationship to the account owner and when they died.
A surviving spouse has the most flexibility. You can roll the account into your own IRA and treat it as yours, which puts distributions on your own timeline. You can keep it as an inherited account and take distributions based on your own life expectancy. If the owner died before their required beginning date, you can also delay until the year the deceased would have reached RMD age.
For most non-spouse beneficiaries inheriting from someone who died in 2020 or later, the 10-year rule applies. You must empty the account by December 31 of the tenth year following the year of death. You can take the money in any pattern during those ten years, but nothing can remain after that deadline.
Certain eligible designated beneficiaries can stretch distributions over their own life expectancy instead of the 10 years. That group includes minor children of the account owner (until they reach majority), disabled or chronically ill individuals, and beneficiaries not more than ten years younger than the deceased. Once a minor child reaches adulthood, the 10-year clock starts.
Any beneficiary can also take a lump-sum distribution at any time. It’s rarely the best tax move, because the full balance becomes taxable income in a single year, but the option is there.