Getting money out of a 401(k) is less about paperwork than about which door you are allowed to use. The plan decides that, not the IRS, and plans differ. The eight steps below walk the options in the order most people should consider them, from the ones that cost nothing to the ones that cost a quarter of the balance.
The 10 percent penalty, and who escapes it
Take money out before age 59 and a half and you normally owe income tax plus a 10 percent early withdrawal penalty on top. The exceptions are narrower than people hope. Leaving your employer in or after the year you turn 55 lets you draw from that employer's plan penalty free, which is the rule of 55 and it does not apply to an IRA. Total and permanent disability, a qualifying domestic relations order in a divorce, certain medical expenses above 7.5 percent of income, and death of the account holder also clear it.
Hardship withdrawals do not. A hardship distribution gets you the money, but the penalty still applies unless you separately meet one of the exceptions above. That surprises a lot of people at tax time.
What actually lands in your account
The plan withholds 20 percent for federal tax on any distribution eligible to be rolled over. That is withholding, not the final bill. If your marginal rate is higher than 20 percent you owe more in April, and the 10 percent penalty is usually not withheld at all, so it arrives as a separate line on the return.
Work a rough number before you file the request. On a 20,000 withdrawal at a 22 percent marginal rate, expect roughly 4,400 in income tax and 2,000 in penalty, leaving about 13,600. State tax comes off that in most states.
The loan, which is usually the cheaper door
If your plan offers loans and you are still employed there, a loan avoids both the tax and the penalty. You can borrow up to half the vested balance or 50,000, whichever is less, and repay it over five years through payroll. Interest goes back into your own account.
The catch is leaving the job. An outstanding balance becomes a deemed distribution, taxed and penalised, though you now have until the tax filing deadline to roll the shortfall into an IRA and undo it.
If you have already left the employer
A rollover to an IRA is not a withdrawal and triggers nothing, and it opens options the plan may not offer, like substantially equal periodic payments. Ask for a direct trustee to trustee transfer. If the cheque comes to you instead, 20 percent is withheld and you have 60 days to deposit the full original amount, making up the withheld part from your own pocket, or the difference counts as a distribution.
Roth 401(k) money moves to a Roth IRA the same way. Once it is there, your own contributions come out tax and penalty free at any time, which makes a Roth IRA a far more flexible emergency source than a 401(k) ever is.
What it costs you in the long run
The tax and the penalty are the visible cost. The bigger one is the growth that money would have done. Twenty thousand pulled at 40, left alone instead at a 7 percent average return, would be about 108,000 at 67. That is the real price of the withdrawal, and no plan statement shows it to you.
Worth exhausting first: an emergency fund, a Roth IRA contribution you already made, a home equity line if you own, or a 0 percent balance transfer if the need is short term. A 401(k) withdrawal is the most expensive money in your life apart from a payday loan, and it is the only one that also shrinks your retirement.
