What Happens If You Withdraw From Your 401k: Penalties and Withholding

If you withdraw from your 401(k), the money is taxed as ordinary income the year you take it, and if you’re under 59½ you generally owe an additional 10% early withdrawal penalty on top of that income tax.1Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules Federal rates for 2026 run from 10% to 37%, so a large distribution can push part of your income into a higher bracket than your paycheck alone would.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 What you actually keep depends on the type of account, your age, whether an exception applies, and how the distribution is handled once it leaves the plan.

How the Withdrawal Gets Taxed

Traditional 401(k) contributions were made with pre-tax dollars, so the IRS treats every dollar you take out as ordinary income for that year.1Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules The distribution stacks on top of your wages and any other income, raising your adjusted gross income and potentially your marginal rate. If your wages put you at $45,000 as a single filer (the 12% bracket for 2026) and you withdraw $20,000, your taxable income rises to $65,000, and part of that withdrawal falls into the 22% bracket.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026

Most states with an income tax treat 401(k) distributions the same way. Nine states have no income tax at all, so residents there owe nothing at the state level. A large distribution can also push a Medicare enrollee’s income above the IRMAA thresholds ($109,000 individual, $218,000 joint in 2026), which raises Part B and Part D premiums for two years after the high-income year.

A designated Roth 401(k) works differently because you already paid tax on the contributions. A qualified distribution, meaning one taken after age 59½ and at least five tax years after your first Roth 401(k) contribution to that plan, comes out entirely tax-free, earnings included. If you don’t meet both conditions, the withdrawal is nonqualified: your original contributions still come out tax-free, but the earnings portion is taxable. The IRS uses a pro-rata formula. If a Roth 401(k) holds $9,400 in contributions and $600 in earnings, and you take $5,000 out, roughly $4,700 is a tax-free return of contributions and $300 is taxable earnings.3Internal Revenue Service. Retirement Plans FAQs on Designated Roth Accounts The five-year clock starts January 1 of the first year you contributed to that Roth 401(k).

The 10% Early Withdrawal Penalty

Taking a distribution before age 59½ generally adds a 10% tax on the taxable portion, on top of the ordinary income tax you already owe.4Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts On a $50,000 early withdrawal from a traditional 401(k), that’s $5,000 in penalty alone, before federal and state income taxes that can easily add another $10,000 or more.

The penalty applies only to the taxable portion. For a traditional 401(k), that’s the whole distribution. For a Roth 401(k), only the taxable earnings part of a nonqualified distribution faces the penalty; your own contributions do not.

Exceptions That Waive the Penalty

Federal law lists several situations where the 10% penalty is waived. You still owe ordinary income tax on a traditional-account distribution, but the extra tax goes away. The main exceptions:5Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions

  • Separation from service during or after the year you turn 55 (the “Rule of 55”), taken from the plan of the employer you left.
  • Total and permanent disability, certified by a physician.6Internal Revenue Service. Retirement Topics – Disability
  • Terminal illness reasonably expected to result in death within 84 months.
  • Distributions to a beneficiary or estate after your death.
  • Payments to a former spouse or dependent under a Qualified Domestic Relations Order.
  • Unreimbursed medical expenses above 7.5% of AGI.
  • A series of substantially equal periodic payments based on life expectancy, taken for at least five years or until you reach 59½, whichever is longer.
  • Distributions forced by an IRS tax levy on the plan.
  • Qualified reservist distributions during active duty of at least 180 days.
  • Up to $5,000 per child for qualified birth or adoption expenses.

The SECURE 2.0 Act added more exceptions starting in 2024, though your plan has to adopt them for you to use them:

Some of these, including the emergency and domestic abuse distributions, let you repay the amount within three years and recover the taxes you paid on it.

The 20% Federal Withholding

When a distribution is paid directly to you instead of being rolled over, the plan administrator must withhold 20% of the taxable amount for federal income tax. You cannot waive it.9Internal Revenue Service. Pensions and Annuity Withholding On a $10,000 traditional distribution, you receive $8,000 and the IRS gets $2,000 as a prepayment.

That 20% is an estimate, not your final bill. If the withdrawal lands you in the 24% bracket, you’ll owe more when you file (plus state tax and the 10% penalty if it applies). If you’re in the 12% bracket, some of the withholding comes back as a refund. A direct rollover, where the administrator sends the funds straight to another eligible plan or IRA without the money passing through your hands, avoids the withholding entirely and defers the tax.10Internal Revenue Service. Topic No. 413, Rollovers From Retirement Plans

Rolling It Over Within 60 Days

If the distribution came to you rather than moving through a direct rollover, you have 60 days from the day you receive it to deposit the funds into another eligible retirement plan or IRA. Complete the rollover in time and the distribution isn’t taxed, except for anything you don’t roll over.11Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions

Here’s the trap: because 20% was already withheld, only 80% actually reached you. To roll over the full amount, you have to add the missing 20% from your own funds and deposit the whole gross amount within the 60 days. If you don’t, the withheld portion is treated as a taxable distribution, and if you’re under 59½ it can also carry the 10% penalty.10Internal Revenue Service. Topic No. 413, Rollovers From Retirement Plans Miss the 60-day deadline entirely and the whole distribution becomes permanently taxable. The IRS can waive the deadline in limited situations such as serious illness or postal error, but a waiver isn’t guaranteed.11Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions

Loans and Hardship Withdrawals

If your plan allows loans, borrowing avoids both the income tax and the penalty as long as you repay on schedule. You can borrow up to the lesser of $50,000 or 50% of your vested balance, and you generally have five years to repay through substantially equal payments made at least quarterly. Loans used to buy a primary home may qualify for a longer term. Interest goes back into your own account. But if you miss payments, or leave your employer with a balance outstanding and can’t repay it, the unpaid amount is treated as a taxable distribution, with the 10% penalty stacked on if you’re under 59½.12Internal Revenue Service. Retirement Plans FAQs Regarding Loans The borrowed funds also stop growing while the loan is out.

Some plans permit hardship withdrawals while you’re still employed, but only for an “immediate and heavy financial need,” and only up to the amount actually required.13Internal Revenue Service. Retirement Topics – Hardship Distributions The IRS safe harbor covers:

  • Medical care for you, your spouse, dependents, or beneficiary.
  • Costs of buying a primary home (not mortgage payments).
  • Tuition and related education fees for the next 12 months.
  • Payments needed to prevent eviction or foreclosure on a primary residence.
  • Funeral expenses.
  • Certain repairs to damage on a primary home.

Employers typically require a written statement that you can’t cover the expense through insurance, other assets, or commercial loans, plus supporting documents such as an eviction notice, medical bills, or a tuition statement.14Internal Revenue Service. Retirement Plans FAQs Regarding Hardship Distributions A hardship distribution is still taxed as ordinary income, and the 10% penalty still applies if you’re under 59½ and no other exception covers you.

What Your Plan Reports to the IRS

After any distribution, your plan administrator sends you Form 1099-R by the end of January of the following year and files the same form with the IRS.15Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498 It shows the total distributed, the taxable portion, federal tax withheld, and a code in Box 7 describing the withdrawal. Common codes include:

  • Code 1: early distribution, no known exception (expect the 10% penalty unless you claim one).
  • Code 2: early distribution with an exception applied.
  • Code 7: normal distribution at 59½ or older.
  • Code G: direct rollover to another eligible plan or IRA.

You report the 1099-R on your federal return. If you qualify for a penalty exception but the form shows Code 1, you can still claim the exception by filing Form 5329 with your return. Keep any documentation supporting the exception in case the IRS asks.

Waiting Too Long Has Its Own Penalty

Distributions aren’t only a question of taking money out early. Starting at age 73, you must begin required minimum distributions from a traditional 401(k) each year, with the first RMD due by April 1 of the year after you turn 73 (or the year after you retire, if you’re still working and your plan allows the delay).16Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs) Fall short and the IRS charges a 25% excise tax on the amount you should have taken, dropping to 10% if you correct the shortfall within two years.17Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs RMDs are calculated from your account balance and an IRS life expectancy table, and they’re taxed as ordinary income like any other traditional 401(k) distribution.