I have a confession to make… back in my early 20s I never contributed to my company’s 401k plan. Oh, how naive I was. My main gripe with putting money into retirement accounts was that I believed the funds were “locked up” until a specific retirement age. I always worried, “what happens if I need to access those retirement funds early!?”
Well, here I am two decades later admitting I made a huge mistake. I should have been maxing out any and all tax-advantage accounts possible back then. I’ve since learned there are MANY ways to tap into retirement accounts early and access funds if needed. And some of these methods don’t even involve penalties or paying extra taxes.
I’ve also learned that there are many ways to save for retirement outside of traditional retirement accounts. Real estate, plain ol’ brokerage accounts, etc.. For folks that are still young and planning to retire early, they can design their nest egg differently to accommodate withdrawals any time they want.
In this post, we’ll discuss all the rules and methods to access retirement funds early. We’ll also talk about some alternative ways to get money if and when you need it before retirement, because robbing your own retirement accounts isn’t the only answer!
1. Withdraw Roth IRA Contributions
Roth IRAs have a handful of powerful benefits. Among them is the ability to withdraw *contributions* tax free and penalty free at any age.
This means that if you contribute $7,000 this year to a Roth IRA, you can withdraw that $7,000 in a few years time without any issues.
But, any investment growth, interest, or dividends earned from those contributions are subject to penalties if withdrawn before retirement age. Both taxes AND a 10% penalty will apply if you take them out prior to age 59½!
For example, let’s say you contributed $7,000 to a Roth IRA this year, and in a few years the balance grows to $10,000. If you are under 59½, you can only withdraw that initial $7,000 contribution tax/penalty free. The additional $3,000 in growth is subject to taxes and the 10% penalty.
Pretty cool, hey? Well… actually it’s not that cool.
Withdrawing Roth IRA contributions might be one of the simplest ways to access retirement funds early, but it can have some serious downsides. That’s because you’re giving up all future tax-free growth and benefits from the funds you withdraw. Any money taken out of a Roth can’t just be “put back in” later. Contribution limits apply each year! So it’s beneficial to keep as much money in your Roth for as long as possible.
2. Set Up a Roth Conversion Ladder
Here’s a secret not many people know… If you convert money into a Roth IRA from other pre-tax retirement accounts (like 401ks or traditional IRAs), you can withdraw those conversions penalty free and tax free, as long as the funds have met a 5 year waiting period.
This method is very popular with the financial independence, retire early crowd. It allows folks to access retirement funds early, without penalty, as long as they plan far enough in advance.
A very important note: Converting money from pre-tax retirement accounts to post-tax retirement accounts is considered a “taxable event.” So you will need to pay taxes on whatever money you convert, within the year that you perform the conversion. But, once converted funds are inside a Roth IRA, they can be taken out penalty free after 5 years.
Here’s an example: Let’s say you’re 40 years old, and have amassed $2M in your 401k account. (Congrats, BTW – that’s a killer accomplishment!) Since you can’t withdraw 401k funds before retirement age without paying a penalty, instead, you convert $50,000 into a Roth IRA. After waiting 5 years, you can withdraw that $50,000 tax and penalty free. Any funds you withdraw just need to meet the 5 year rule.
Taking this one step further, you could repeat the same conversion annually. Converting $50,000 each year for multiple years, you could then potentially withdraw $50,000 each and every year, too. With each conversion sitting in the Roth IRA for 5 years, there would be no early withdrawal penalties. This strategy is also referred to as a Roth Conversion Ladder.
Roth conversions require A LOT of careful planning. It’s a perfect strategy for those that need to access retirement funds early, but not immediately.
3. The IRS Rule of 55
Another way to access retirement funds early is the Rule of 55. Under this rule, workers who have an employer sponsored 401k or 403b account may avoid the usual 10% penalty for early withdrawals. Here are the details:
Eligibility: The rule of 55 only applies if you leave your employer (get laid off, fired, or just quit) in the same calendar year you turn 55 or older. If you are a public health employee, it’s age 50!
Penalty-Free Withdrawals: Workers can withdraw funds from their *current* employer’s retirement plan without incurring the 10% penalty. However it’s important to remember that you will still owe income taxes on all withdrawals.
Type of Accounts: The Rule of 55 only applies to the current employer’s retirement plan (401k’s and 403b’s). If you have old employer 401k accounts, penalty free withdrawals do not apply. Also it’s not applicable to traditional IRAs or funds that have been rolled over to IRAs.
Example: Let’s say you turn 55 this year and want to retire. Instead of waiting until 59 ½ to access your 401k funds penalty free, you can take withdrawals from your current employer’s 401k early, without the 10% penalty.
This is a great way for folks to access retirement funds early, allowing them to depart from an employer ~4 years before full retirement age. Even if it only allows access to a small amount of funds penalty-free, it’s important information if you are in your 50s and want to quit working!
4. Substantially Equal Periodic Payments (SEPP)
SEPPs allow you to access retirement funds early from your IRA without incurring the 10% early withdrawal penalty. However, there’s a catch: you must commit to taking fixed, regular withdrawals over a specific period of time.
Even worse, once the schedule is set in motion, you can’t make any changes (until you reach age 59 ½). This inflexibility makes it a very complex strategy. It should only be used as a last resort option for early retirees.
There are only three eligible ways to calculate payments and set up a distribution schedule. All of them are designed to make small payments over a long period of time, based on your life expectancy.
Important note: even with a SEPP, income taxes are still owed on any withdrawn amount. The SEPP simply waives the extra 10% penalty for early withdrawal.
5. IRS Rule 72(t) Special Exemptions
There are a handful of special circumstances where the IRS will waive the usual 10% penalty for early withdrawals from retirement accounts. And good news, some exemptions cover both employer-sponsored plans, as well as traditional IRAs!
The entire list of IRS 72(t) Exemptions are listed here, but here are some of the main ones:
- Birth or Adoption: For each new child that joins your family you can withdraw up to $5,000 to cover qualified birth/adoption expenses.
- Medical: You can withdraw unreimbursed medical expenses, up to 7.5% of your Adjusted Gross Income. You can also cover health insurance premiums while unemployed with IRA withdrawals.
- Homebuyers: Qualified first time home buyers can withdraw up to $10,000 penalty free from their IRA. But, this is only for IRAs, *not 401k withdrawals*, watch out!
- Terminal illness: If you’re certified by a physician as being terminally ill, you can take out penalty free withdrawals. Also if you die, then your money can be taken out penalty free for survivors.
- Emergency personal expenses: This is a new rule! You are allowed a single $1,000 distribution per calendar year for personal or family emergency expenses (made after 12/31/2023)
- Education: You can withdraw funds to cover qualified higher education expenses from your IRA (*Not employer sponsored plans).
As you can see, these provisions were designed mostly as hardship withdrawals. They were made to help folks in dire circumstances that might need early access to retirement funds in a quick manner. They don’t allow people to tap big chunks of their retirement nest egg. But, these methods can help cover expenses in a pinch, without penalties.
6. Borrow from Your 401k
Instead of withdrawing funds completely from your retirement account, you might be able to access money temporarily via a 401k loan. If you make a plan to pay the money back in a timely manner, this could be a solid strategy (usually it’s not, though)…
First, you should know that not all employers offer 401k loan programs. So definitely check with your HR department to see if your company plan allows it!
Next, it’s important to know that if you get terminated or leave your job while you have an outstanding loan, the entire balance could be deemed a taxable withdrawal. Not only would you be subject to tax on the entire amount if not paid back in full immediately, but you’d owe the 10% early withdrawal penalty as well.
Generally, 401k loans need to be repaid within a 5 year period. Not only do you pay back the amount you owe, there’s an interest rate attached too. This is generally 1-2% above the current prime rate. There’s also an IRS imposed limit on how much you can borrow. The maximum 401k loan is $50,000 or 50% of your vested account balance, whichever is less.
401k loans might sound like a good idea if you’re in a pickle and need to access retirement funds early. But they should be considered a last resort because of the high risks involved if something goes wrong.
7. HSA “Shoebox” Rule
Health Savings Accounts often get overlooked when it comes to retirement planning. But they are actually one of the most tax efficient vehicles for growing wealth – if you know how to use them the right way.
HSA’s have a triple tax advantage. This means the money you put in is tax-free, all investment growth is tax free, and when you take money out (for qualified medical expenses) withdrawals are tax free. Woohoo!
Here’s the secret most folks don’t know: There’s no time limitation to submit claims for qualified health expenses. So if you had medical bills earlier in life (and paid out of pocket for them at the time), you could potentially use those receipts today and withdraw money penalty free from your HSA. You’d just need to have copies of those old receipts to justify the claim. (This is why it’s referred to as the “shoebox” rule, as in keeping your health expense receipts in a shoebox).
Not everyone has access to a HSA. And the annual contribution limits are quite low comparative to other retirement account types. But if you do have access, try contributing and investing as much as you can each year. If you can leave all the money untouched (and pay out of pocket for medical expenses, while saving those receipts), you can withdraw funds in later years, without penalty. Best of all, you’ll be taking full advantage of tax free investment growth for years (or decades) in the meantime.
Here’s a detailed post about the ins and outs of HSA benefits, including a HSA shoebox strategy example.
8. Other Retirement Investing Alternatives
Tax-advantaged investing accounts are awesome. But they’re not the be-all end-all when it comes to saving for retirement. If you want maximum options when it comes to flexible withdrawals, you should invest your money across multiple types of retirement assets.
Pre-tax and post-tax advantaged accounts should be utilized (and prioritized to a certain point). Roth IRAs are a must for most people, and so is contributing to your 401k to take full advantage of any employer match. But, if you want to access retirement funds early without navigating any of the special rules mentioned above, here are some other investment options you can consider:
Brokerage accounts: These plain old investment accounts don’t come with any special tax advantages. You invest after-tax dollars. But they do have zero fees, tons of flexibility, and no investment limits.
Real estate investments: Buying a rental property can provide cash flow, options to do a cash-out refinance, or even the ability to sell and generate cash if needed. On the down side, rental real estate can be illiquid and labor intensive.
High yield savings accounts: For shorter term financial goals (like buying a new car or saving up a down payment on a house) retirement accounts are the wrong place to save that money. Instead, short-term savings accounts allow you to earn some interest while having full access to that money the instant you need it.
All in all, spreading your nest egg across multiple account types gives you the most flexibility. Not just for penalty-free withdrawals, but also getting the most important tax benefits available to you.
Should you access retirement funds early?
Just because there are legit ways to access retirement funds early, does that mean you should pull from those accounts if you need money?
The answer is no. Taking money out of retirement funds earlier than planned should be the absolute last resort. Unless, of course, you are actually retiring early! The long-term damage you will do to your future investment growth greatly outweighs any short term gain you get from accessing money early. Once those dollars get taken out, they aren’t working for your future anymore.
Think of it this way – the whole point of investing in tax advantage retirement accounts is to leave everything untouched for as long as possible. The longer funds stay invested and tax sheltered, the more compound interest and growth you’ll end up with.
Impact of an Early 401k Withdrawal
Here’s a hypothetical scenario to illustrate the impact of taking an early withdrawal from your 401k account, instead of leaving those funds invested.
Let’s say you’re 35 years old and have a 401k balance of $200,000. Not bad!
Now let’s say you’ve really been wanting to buy a second car, because all the families in your neighborhood have 2 cars, and you feel pressure to get one too. Since you don’t have much wiggle room in your monthly budget and no cash savings pile, you look to withdraw $50,000 out of your 401k to buy the car.
Here is how it will stunt your retirement growth…
First, after the 10% penalty and withheld taxes, a $50,000 withdrawal from your 401k only works out to be $33,000 cash in hand. The new car you’re buying just got a whole lot smaller than you originally thought!
Next, due to the missed compound growth (we assumed an 8% return), when it comes time to retire 30 years later you have over half a million dollars LESS.
Is that second car really worth $500k in retirement funds!?!?
Noooooooooooooo. 🙅‍♂️🙅‍♂️🙅‍♂️
**here’s an online calculator from Empower where you can run your own simulations and see the impact of early 401k withdrawals**
But what if you need money, ASAP!?
Most people who withdraw funds from their retirement accounts early are trying to solve a short term financial problem. But they overlook many other (less dangerous) avenues to access quick cash.
- Home equity loans: If you have a decent chunk of equity in your primary residence you can usually get a quick loan. This can be a smart solution but don’t treat your house like a piggy bank either!
- Cash out refinance: This is less quick than a HELOC. But if mortgage rates are good then it could be a great option to get cash out. If you’re trading out a 3% mortgage for a 7% mortgage it’s likely a terrible idea though.
- Reduce living expenses: Switching to a bare bones budget for a few months can usually solve a temporary financial squeeze. Frugality is always a great solution!
- Consolidating debt: Using 0% financing could be an option, or consolidating debts to a lower rate. Just make sure you have plans to pay back all loans before introductory rate periods expire. Debt consolidation can seem like the holy grail solution, but it can also create a false sense of security, leading to overall higher levels of debt.
- Negotiate bills or debts: If you have a bill you can’t pay, try to ask for a payment plan or options to pay over time. Even if this means paying more interest, it might be better than robbing your own retirement accounts.
- Ask for a raise or start a side hustle: If you find that there’s more month than money, try picking up a side hustle or getting some temporary gig work.
All in all, before you plan to access retirement funds early to solve a financial crisis, think about all of the alternatives and weigh the long-term pros and cons.
The Bottom Line:
If you are planning to retire early, there are several ways to access retirement funds early without paying the usual 10% penalty. Roth conversions are an awesome choice, as well as SEPP plans for smaller IRA balances. Also, investing in other flexible retirement accounts like brokerage accounts or rental real estate can give you more flexibility with predictable cash flow in retirement.
If you’re going through a temporary financial hardship, there are some IRS provisions that allow for penalty free retirement withdrawals. But it’s crucial to weigh the long-term consequences and understand any tax implications. Try to think of other ways to address your short-term money needs without jeopardizing your long-term retirement security.
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