10 Penalty-Fee Withdrawal Options For Retirement Plans
This week, I want to dive into 10 of the most popular ways you can access your 401(k) or IRA funds without facing the dreaded early withdrawal penalty.
Typically, the rule is that you must wait until age 59 ½ to access your retirement accounts without incurring penalties. If you withdraw money before that age, you’ll typically face a 10% early withdrawal penalty, in addition to regular income tax, if you’re withdrawing from pre-tax accounts.
That said, there are ways to bypass the penalty and access your funds early. Let’s dive into these 10 methods—starting with the most common and ending with one of the best-kept secrets in the world of retirement planning. (MAKE SURE TO STICK AROUND FOR THE LAST ONE)
#1: UNREIMBURSED MEDICAL EXPENSES
One of the most common ways to access your retirement funds penalty-free is to pay for unreimbursed medical expenses.
If your medical bills exceed 7.5% of your adjusted gross income (AGI), you can withdraw money from your IRA or 401(k) to cover these costs.
HOW TO QUALIFY
To qualify, you must withdraw the funds in the same year that the medical expenses were incurred. You’ll also need to submit your medical bills along with the necessary forms to apply for this penalty waiver.
It’s also worth noting that the IRS typically requires medical expenses to exceed 10% of your AGI for tax deductions, but this exception allows you to bypass that threshold.
The best part? Most medical bills qualify, as the IRS classifies them as “necessary medical expenses.”
Peace of mind through trusted advice - Check out this week’s episode on: Can Elon Musk and Doge Take Away My Social Security Benefit? #247
#2: DISABILITY
If you become disabled and are unable to work, you may be able to take penalty-free withdrawals from your IRA or 401(k). The IRS has specific guidelines for what qualifies as total or permanent disability, so you’ll need to provide documentation.
This is a crucial way to access your retirement savings early if you’re no longer able to earn income due to disability.
This option is available for both IRAs and 401(k)s, which is a helpful perk if you’re navigating a tough time.
#3: HEALTH INSURANCE PREMIUMS (While Unemployed)
If you find yourself unemployed for at least 12 consecutive weeks, you can use IRA funds to pay for health insurance premiums without incurring the 10% penalty. While this exemption doesn’t apply to 401(k) plans, it is available for IRAs.
It’s recommended that you open a separate bank account to receive transfers from your IRA specifically for paying insurance premiums. This helps ensure you have a clear paper trail in case of an audit.
Shipped to your door!
Available on Amazon Marketplace (click the image)
#4: DEATH OF THE ACCOUNT HOLDER (Inherited Retirement Accounts)
Though this one isn’t beneficial if you’re the account holder, it can help you if you inherit a retirement plan.
If you inherit an IRA or 401(k) from a:
Spouse
Family member
Parent
And you’re not yet 59 ½, the 10% early withdrawal penalty is waived. This can be incredibly helpful in a time of grief, giving you the financial flexibility to access the inherited funds without facing additional penalties.
Keep in mind, that there are specific requirements and paperwork to follow when inheriting a retirement account, so it’s worth reading more about inherited retirement plans.
#5: IRS DEBT (Levy Against Your Retirement Account)
If you’re in debt to the IRS, they may place a levy against your IRA. However, if you need to pay off that debt and want to avoid further complications, you can withdraw money from your IRA or 401(k) to settle the amount owed.
Fortunately, the IRS waives the 10% penalty for these types of withdrawals, which can provide much-needed relief if you find yourself in financial distress.
Take my course at your pace through an on demand video library.
#6: FIREST-TIME HOME PURCHASE
You can withdraw up to $10,000 from your IRA for a first-time home purchase, but this is a lifetime option. Once you’ve used the $10,000, that’s it! You won’t be able to access another $10,000 for future home purchases.
This option is available for IRAs but does not apply to 401(k)s, so if you’re planning to use your 401(k) for a first-time home purchase, unfortunately, the penalty waiver won’t apply.
#7 HIGHER EDUCATION EXPENSES (IRA Only)
If you or a family member are pursuing higher education, you can use your IRA funds to pay for tuition, fees, and other related qualified expenses.
However, the following expenses don’t qualify:
Room and board
Insurance
Medical expenses
Transportation costs
So, you will need to keep this in mind when budgeting for higher education.
This option is available only for IRAs, not 401(k)s. So, if you're considering tapping into your retirement funds to help with education costs, be sure to check if your expenses qualify and understand that this rule only applies to IRA accounts.
#8: SUBSTANTIALLY EQUAL PERIODIC PAYMENTS (SEPP)
If you retire early and want access to your retirement funds, you can use the Substantially Equal Periodic Payments (SEPP) rule. This allows you to withdraw money from your IRA or 401(k) without the 10% penalty, but you must commit to taking regular, equal payments for at least five years or until you turn 59 ½, whichever is longer.
For example, if you retire at 54 and want to start using your retirement funds right away, you could set up a plan to take withdrawals for six years.
However, you must stick to this plan—you can’t modify the withdrawal amount or stop withdrawals midway. This is a very rigid option, and you should be careful before setting it up. Make sure you’re comfortable with taking the money out for the long term, even if your financial situation changes.
#9: TERMINAL ILLNESS
Unfortunately, if you're dealing with a terminal illness, the rules differ depending on whether you're accessing an IRA or a 401(k). If you have a terminal illness, you can take penalty-free withdrawals from your 401(k), but you must provide a physician’s certification of your condition.
Sadly, this exemption doesn’t apply to IRAs, so this is a specific option only available for 401(k) holders. While it’s a difficult situation, it’s worth knowing this option exists should you find yourself in this position.
#10: SEPARATION FROM SERVICE AT AGE 55
Perhaps one of the best options for those who leave their job between the ages of 55 and 59 ½, this rule allows you to access your 401(k) or other qualified retirement plans without the 10% penalty if you leave your job at age 55 or older.
The key here is that you must leave your job during the calendar year when you turn 55. If you leave before you turn 55, you won’t qualify. But if you’re 55 or older when you leave, you can withdraw funds from your 401(k) without facing the early withdrawal penalty.
This rule only applies to qualified plans, such as 401(k)s, and is a valuable benefit for those in the 55 to 59 ½ age range who might need to access their funds after leaving a job.
It’s worth noting that if you roll your 401(k) into an IRA, you lose this ability. So, if you plan to leave your job between 55 and 59 ½, you might want to consider leaving some of your funds in your 401(k) to take advantage of this penalty-free option.
In some cases, public safety employees, such as air traffic controllers, may even qualify for this rule at age 50 instead of 55, giving them even earlier access to their retirement funds. If you fit into this category, it’s worth checking with your plan administrator to confirm the specific rules.
If you prefer to learn in video format. Make sure to check out my YouTube channel! Don’t forget to subscribe!
CLOSING THOUGHTS
There are many ways to access your retirement funds before age 59 ½ without facing the usual 10% penalty. Whether it’s for higher education expenses, a terminal illness, or due to separation from service, it’s important to know which options are available to you—and which rules apply.
As always, be sure to follow the necessary procedures and keep proper documentation when using these exemptions, so you’re not caught off guard when it’s time to file your taxes. Even if you avoid the 10% penalty, remember that the funds you withdraw will still be taxable if they’re pre-tax funds.
If you have a question or topic that you’d like to have considered for a future episode/blog post, you can request it by going to www.retirewithryan.com and clicking on ask a question.
As always, have a great day, a better week, and I look forward to talking with you on the next blog post, podcast, YouTube video, or wherever we have the pleasure of connecting!
Written by Ryan Morrissey
Founder & CEO of Morrissey Wealth Management
Host of the Retire with Ryan Podcast