The worst ways to withdraw from retirement accounts share a single trait: they turn money you already own into a tax bill you didn’t have to pay. Cashing out a 401(k) at a job change, pulling funds before age 59½, mishandling a rollover, skipping a required minimum distribution, tapping Roth earnings too soon, and lump-summing an inherited IRA can each strip 25% to 50% off the balance you touch. Some of the damage shows up on this year’s tax return. The rest shows up decades later, in the growth that never happened.
Cashing Out a 401(k) When You Change Jobs
This is where the most retirement wealth quietly disappears. Research covering more than 160,000 workers found that roughly 41% cashed out at least part of their 401(k) when they changed jobs, and the vast majority of those drained the entire account.
Consider a 30-year-old in the 22% federal bracket who cashes out $20,000. Federal income tax takes $4,400, the early withdrawal penalty takes another $2,000, and they walk away with $13,600. The visible cost is $6,400. The invisible cost is much larger: at a 7% average annual return, that $20,000 would have grown to roughly $150,000 by age 60.
The fix is a direct rollover, where the money moves from the old plan straight to an IRA or your new employer’s plan without ever passing through your hands. No withholding, no taxes, no penalty. Many plans force out balances under $5,000, so if your old employer sends a distribution notice, choose the direct rollover option before a check gets cut in your name.
Taking an Early Withdrawal Before Age 59½
Federal law adds a 10% penalty to any amount you withdraw from a qualified retirement plan before age 59½, applied to the portion included in your gross income.1Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts That sits on top of regular income tax, because traditional 401(k) and IRA contributions were never taxed going in.2Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
Say you’re in the 24% bracket, which in 2026 applies to taxable income above $105,700 for single filers, and you pull $50,000 from a traditional IRA.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 You owe $12,000 in federal income tax plus a $5,000 penalty, leaving $33,000. If the distribution pushes income above $201,775, part of it hits the 32% bracket. Add state income tax and you can lose more than 40 cents on the dollar.
Several exceptions to the 10% penalty exist, and people sometimes take the full hit when they didn’t have to:
- Rule of 55. If you leave your employer in the year you turn 55 or later, you can withdraw from that employer’s 401(k) or 403(b) penalty-free. It only works for the plan you just left. Roll the money to an IRA first and you lose this exception.
- Substantially equal periodic payments. You can set up a series of fixed withdrawals from an IRA or employer plan using IRS-approved methods and skip the penalty, but you must maintain the schedule until the later of five years or age 59½. Break it early and the IRS imposes a recapture tax on everything you already withdrew.4Internal Revenue Service. Substantially Equal Periodic Payments
- Birth or adoption. Each parent can withdraw up to $5,000 penalty-free within one year of a child’s birth or a finalized adoption.
- First-time homebuyer, IRA only. Up to $10,000, lifetime cap, if you haven’t owned a principal residence in the prior two years.
None of these exceptions eliminate the income tax on the distribution. They only remove the penalty. The full amount still lands on your return as taxable income.
Accepting a Check Instead of a Direct Rollover
The method you use to move retirement money determines whether the government skims 20% off the top. A direct rollover transfers funds straight from one custodian to another with no withholding. An indirect rollover means the plan cuts a check to you personally, and your former employer’s plan is required to withhold 20% for federal taxes before you see it.5Internal Revenue Service. Topic No. 413, Rollovers from Retirement Plans
Here’s the trap. You still have to deposit the full original amount into the new retirement account within 60 days to avoid taxes and penalties.6Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions On a $100,000 distribution, the plan withholds $20,000 and hands you $80,000. To complete a tax-free rollover, you have to come up with the missing $20,000 from your own pocket and deposit $100,000. Most people don’t have that lying around, so they deposit only the $80,000 they received. The $20,000 shortfall is then treated as a taxable distribution, and if you’re under 59½, it also triggers the 10% penalty.
You do get the $20,000 back eventually, either as a smaller balance due or a refund when you file. But it can be months away, and in the meantime you’ve permanently lost the tax-sheltered status of that money. Insist on a trustee-to-trustee transfer every time you move retirement funds and the whole problem disappears.
Missing the 60-Day Rollover Window or the One-Per-Year Rule
If you do take an indirect rollover, the 60-day clock is unforgiving. You have exactly 60 days from the date you receive the distribution to redeposit it into a qualifying retirement account. Miss the deadline by a single day and the IRS treats the entire amount as a permanent taxable distribution.6Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
The IRS allows self-certification for late rollovers in specific situations, including serious illness, a death in the family, a postal error, an error by the financial institution, or incarceration. You must complete the rollover as soon as the obstacle clears, and a safe harbor treats you as timely if you finish within 30 days after the reason for the delay no longer applies.7Internal Revenue Service. Revenue Procedure 2020-46 “I forgot” isn’t on the list.
A separate rule limits you to one indirect IRA-to-IRA rollover in any 12-month period.8Internal Revenue Service. Rollover Chart A second indirect rollover inside that window is treated as a taxable distribution. Worse, the money deposited into the receiving IRA can be classified as an excess contribution, which carries a 6% excise tax for every year the excess sits in the account.9Office of the Law Revision Counsel. 26 USC 4973 – Tax on Excess Contributions to Certain Tax-Favored Accounts Direct trustee-to-trustee transfers are not subject to the once-per-year limit, which is another reason to use them.
Skipping a Required Minimum Distribution
Once you reach a certain age, the IRS requires annual withdrawals from traditional retirement accounts whether you need the money or not. Under SECURE 2.0, if you were born between 1951 and 1959, required minimum distributions begin at 73; if you were born in 1960 or later, they begin at 75.10Congress.gov. Required Minimum Distribution (RMD) Rules for Original Owners Your first RMD is due by April 1 of the year after you reach the applicable age. Every subsequent RMD is due by December 31.11Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
That April 1 grace period creates its own trap. Delay your first RMD into April and you’ll owe two RMDs in the same calendar year, both taxable, which can push you into a higher bracket and raise Medicare premiums that key off your adjusted gross income.
Skip an RMD and the IRS imposes an excise tax of 25% on the shortfall between what you were required to withdraw and what you actually took.12Office of the Law Revision Counsel. 26 U.S. Code 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans A missed $30,000 RMD means a $7,500 penalty on top of the income tax you’ll still owe on the distribution itself. Forgetting, miscalculating, and not knowing the rules all count the same.
There’s a real escape valve. Correct the mistake inside the “correction window,” generally by taking the missed distribution and filing Form 5329 within about two years of the original deadline, and the penalty drops from 25% to 10%.12Office of the Law Revision Counsel. 26 U.S. Code 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans Fix it fast rather than hoping no one notices.
Pulling Roth IRA Earnings Before the Account Qualifies
The Roth IRA is a simple deal: pay tax on the way in, and if you follow the rules, the gains come out tax-free. The trouble starts when people tap the earnings before the account qualifies. A qualified distribution requires both that you’ve held any Roth IRA for at least five tax years and that you’ve reached 59½, or that you meet another qualifying event like disability or a first home purchase up to $10,000.13Office of the Law Revision Counsel. 26 USC 408A – Roth IRAs Miss either requirement and the earnings portion becomes taxable income plus a 10% early withdrawal penalty.
The five-year clock starts on January 1 of the tax year for which you made your first Roth contribution. Open a Roth in March 2024 and designate it as a 2023 contribution, and the clock started January 1, 2023. A common miscalculation is opening a first Roth after age 55 and assuming the earnings will be available tax-free at 59½. If you haven’t held any Roth for five years by then, reaching the right age isn’t enough.
The IRS ordering rules soften this. Withdrawals are treated as coming out in a fixed sequence: direct contributions first, then conversion amounts, then earnings. You already paid tax on your contributions, so you can withdraw up to your total contribution basis tax-free and penalty-free at any age. The penalty risk only surfaces once you’ve withdrawn past your contributions and conversions and start dipping into gains. Someone in the 22% bracket who pulls $10,000 of earnings from a non-qualified Roth owes $2,200 in income tax and a $1,000 penalty, wiping out the reason to use a Roth in the first place. Stopping at your contribution basis avoids both.
Draining an Inherited IRA in a Single Year
Inheriting a retirement account carries its own set of traps, and the rules changed sharply for accounts inherited after 2019. Most non-spouse beneficiaries are now subject to a 10-year rule: the entire account has to be emptied by December 31 of the tenth year after the original owner’s death. The old stretch-over-your-lifetime strategy is gone for most heirs.
The worst move is ignoring the account for nine years and liquidating the balance in year ten. A large inherited IRA dumped into one tax year can push you into the highest federal brackets, with the top rate of 37% applying to income above $640,600 for single filers in 2026.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A $500,000 traditional IRA taken in one year will be taxed at rates far higher than the same amount spread across the full window.
There’s a second wrinkle. If the original owner had already begun taking RMDs before death, you must take annual distributions in years one through nine and clear the balance by the end of year ten. Skip those annual distributions and the same 25% shortfall penalty applies.12Office of the Law Revision Counsel. 26 U.S. Code 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans If the original owner died before starting RMDs, you have more flexibility on timing inside the window, but the account still has to be fully distributed by the deadline.
Planning distributions across the full 10 years, taking larger amounts in years when your other income is low and smaller ones when it’s high, can save tens of thousands compared to a lump-sum liquidation at the end.