How to withdraw money from 401(k): Essential retirement strategies

What you need to know about 401(k) withdrawals

If you have a 401(k), you’ll eventually want to access that money. A 401(k) is a type of retirement plan sponsored by your employer, and the summary plan description outlines the rules for accessing your plan account. The timing of your withdrawals affects both your tax bill and whether you’ll face penalties.

Taking early withdrawals from your retirement plan—before reaching age 59½—can result in additional penalties and reduce your long-term savings. Here’s what you need to know about when and how to withdraw from your 401(k).

When 401(k) withdrawals become penalty-free

Many people think 401(k) withdrawals become tax-free at a certain age, but that’s not quite right. Traditional 401(k) withdrawals are always taxable as ordinary income, regardless of your age.

What changes at age 59½ is the penalty. You can withdraw money without facing the 10% early withdrawal penalty once you reach this age.

That said, there’s another rule that might help you earlier. If you retire or leave your job during the calendar year you turn 55 or later, you can withdraw money early from your workplace retirement plan and withdraw money penalty free from that employer’s 401(k) under the “Rule of 55.” This applies only to public safety employees starting at age 50.

Just remember: This exception works only for the 401(k) from your most recent employer, not other retirement accounts.

What happens with early withdrawals

Taking money from your 401(k) before age 59½ typically means you’ll pay both ordinary income taxes and a 10% early withdrawal penalty. These early distributions include any withdrawals made before reaching retirement age and may be subject to penalties unless you qualify for an exception.

That said, several exceptions exist for penalty-free early withdrawals. You may avoid the penalty if you face:

• Total and permanent disability
• Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income
• Qualified birth or adoption expenses (up to $5,000)
• First-time home purchase (up to $10,000 from IRAs only)
• Emergency personal expenses up to $1,000 per year
• Qualified disaster recovery distributions up to $22,000

A hardship withdrawal may be allowed if you have an immediate and heavy financial need, such as medical emergencies or other urgent expenses. Hardship withdrawals are subject to specific IRS rules, and you must demonstrate your financial need to qualify. If you withdrew funds for a hardship, you may face tax consequences and restrictions on future contributions. These withdrawals are generally considered a last resort due to their long-term impact.

Emergency withdrawals are a new option under recent legislation, allowing limited access to retirement funds for urgent needs under specific conditions.

Another way to access retirement funds early is through substantially equal payments (SEPP), which allow penalty-free withdrawals if you follow IRS-approved calculation methods for regular, predictable payments.

It’s also important to compare 401(k) early withdrawals to IRA withdrawals, as the rules, exceptions, and tax implications can differ between these types of retirement accounts.

Your 401(k) plan may also allow loans of up to 50% of your vested balance, with a maximum of $50,000. These loans typically must be repaid within five years. Unlike withdrawals, loans aren’t taxable if you stick to the repayment terms.

Required minimum distributions explained

Once you turn 73, the IRS requires you to begin taking withdrawals from your traditional 401(k) and IRA accounts. These are called required minimum distributions, or RMDs.

The IRS mandates these withdrawals to ensure retirement funds don’t grow tax-deferred forever. RMDs are taxed as ordinary income and may increase your federal income taxes.

Your RMD amount gets calculated by dividing your account balance as of Dec. 31 of the previous year by a life expectancy factor the IRS publishes. Missing your RMD triggers a 25% penalty on the amount you should have withdrawn.

You have until April 1 of the year following when you turn 73 to take your first RMD. After that, you must take RMDs by Dec. 31 each year. RMDs must be paid by the deadline each year to avoid penalties. Taking both your first and second RMDs in the same calendar year could push you into a higher tax bracket.

Withdrawal strategies: finding what works for you

Once you understand the basic withdrawal rules, you need to decide how to actually take money out of your retirement account. Your withdrawal strategy determines how long your money lasts, how much you pay in taxes, and how much of your retirement account remains invested for future growth. Your investing approach can significantly affect the long-term growth of your retirement savings.

Here’s what you need to know about the most common approaches, which can be applied to various retirement plans, not just 401(k)s.

The 4% rule

The 4% rule gives you a simple way to think about retirement withdrawals. You withdraw 4% of your total retirement savings in your first year, then adjust that amount each year for inflation. The 4% rule is intended to cover your living expenses throughout retirement.

If you have $1 million saved, you’d withdraw $40,000 in year one. The next year, you might withdraw $40,800 if inflation was 2%. Withdrawing more than 4% per year could leave you with less money later in retirement.

This approach assumes a balanced portfolio of about 50% stocks and 50% bonds. It’s designed to make your money last roughly 30 years.

The 4% rule works as a good starting point, but your situation may call for a different approach.

Fixed-dollar vs. fixed-percentage withdrawals

These two strategies handle market ups and downs very differently.

With fixed-dollar withdrawals, you take out the same amount each period. You might withdraw $40,000 every year regardless of how your investments perform. This gives you predictable income, but it doesn't adjust for inflation or market changes.

Fixed-percentage withdrawals work differently. You take a set percentage of your current portfolio value each year.

If you start with $1 million and use a 4% rate, you withdraw $40,000 the first year. If your portfolio grows to $1.1 million, you'd withdraw $44,000 the next year. If it drops to $900,000, you'd withdraw $36,000.

The percentage approach automatically adjusts to market conditions. You spend less when markets are down and more when they're up.

Systematic withdrawal plans

A systematic withdrawal plan focuses on preserving your principal. You only withdraw the income your investments generate - things like dividends and interest.

This strategy helps protect your original investment while potentially allowing growth over time. The downside? Your income fluctuates with market performance and may not keep up with inflation.

The bucket strategy

The bucket approach divides your retirement money into separate accounts based on when you’ll need it:

• Short-term bucket: Cash and liquid investments for your immediate needs, typically one to two years of expenses. Some retirees consider using a home equity loan or home equity line as an alternative to withdrawing from retirement accounts for immediate needs.
• Medium-term bucket: Fixed income securities like bonds for expenses two to 10 years out.
• Long-term bucket: More aggressive investments like stocks for needs beyond 10 years.

This approach gives you peace of mind by ensuring cash is available for near-term expenses. As you use money from your short-term bucket, you replenish it with gains from the other buckets.

The bucket strategy also helps you avoid selling investments at bad times. If stocks are down, you can rely on your cash bucket while waiting for markets to recover.

How to reduce taxes on your 401(k) withdrawals

The way you withdraw money from your 401(k) and other retirement accounts can make a huge difference in how much you pay in taxes. Smart withdrawal planning can help you keep more of your money and potentially make your savings last longer.

Withdrawals from Roth accounts, which are funded with after-tax dollars, are generally tax free. In contrast, distributions from traditional individual retirement accounts (IRAs) and other pre-tax retirement accounts are taxed as ordinary income, and you may need to pay federal taxes on these withdrawals. Each account type, including IRAs and Roth accounts, has different tax rules that can impact your overall tax liability.

(We do not provide legal or tax advice; always seek guidance from a qualified tax professional for your specific situation.)

Which accounts should you tap first?

Most financial advisors recommend a specific order: withdraw from taxable accounts first, then tax-deferred accounts like traditional 401(k)s and IRAs, and finally from tax-free Roth accounts. The idea is to let your tax-advantaged accounts grow as long as possible.

That said, research shows this traditional approach isn't always best. A proportional withdrawal strategy often works better. Instead of draining one account type at a time, you take money from different accounts simultaneously based on their balance percentages.

Here's what the numbers show: this approach can extend how long your money lasts by one to three years and reduce lifetime taxes by approximately $28,000-$33,000 for a typical couple. Even better results come from a personalized approach that withdraws from tax-deferred accounts up to specific tax bracket thresholds.

Protecting your Social Security benefits from taxes

Social Security benefits become partially taxable when your "combined income" hits certain thresholds. Your combined income is calculated by adding your adjusted gross income, tax-exempt interest, and 50% of your Social Security benefits. When your income reaches higher thresholds, as much as 85% of your Social Security benefits can become taxable.

The timing of your 401(k) withdrawals can create what's called a "tax torpedo." Each additional dollar of income can cause an extra $0.85 of Social Security benefits to become taxable, effectively pushing your marginal tax rate to 185% of your bracket rate.

You can avoid this trap by spreading out withdrawals evenly throughout retirement rather than taking large amounts from tax-deferred accounts later when Social Security kicks in.

When Roth conversions make sense

Converting money from traditional IRAs to Roth accounts can be particularly smart before your Social Security benefits begin. You'll pay taxes upfront, but then enjoy tax-free growth and withdrawals while reducing your future required minimum distributions.

The best time for Roth conversions is during low-income years or early in retirement, especially if you expect to be in higher tax brackets later. For married couples, aggressive Roth conversions while both spouses are alive can prevent the surviving spouse from being pushed into higher tax brackets.

Just remember: this strategy may reduce lifetime taxes by over $200,000 in some cases. The key is timing these conversions when you can fill up lower tax brackets without triggering the Social Security tax torpedo.

Common 401(k) withdrawal mistakes to avoid

Even careful planning can’t protect you from every pitfall when withdrawing from your 401(k). Withdrawing funds should be considered a last resort after exploring all other options, as it can have significant long-term consequences. In some cases, taking a loan from your 401(k) may be preferable to a withdrawal, but loans also come with their own risks and rules.

Here’s what you need to know about the most common errors retirees make.

Taking out too much money too early

Nearly one-third of retirees (31%) reported spending more than they could afford in 2024—a concerning increase from just 17% in 2020. This often happens when people underestimate retirement expenses or expect their investments to perform better than they actually do.

Taking too much money early in retirement becomes especially damaging if the market drops at the same time. This creates a double hit that your portfolio may never recover from.

Your early withdrawal years set the tone for your entire retirement.

Focusing only on getting your money out

Many retirees think about accessing their money without considering what it will cost them in taxes. Early withdrawals before age 59½ trigger a 10% penalty on top of ordinary income taxes.

That said, withdrawals can also push you into higher tax brackets. This potentially causes up to 85% of your Social Security benefits to become taxable.

Underestimating how long you'll live

Two-thirds of pre-retiree men underestimate their average life expectancy by five or more years. This miscalculation can lead people to save too little for retirement.

If you're healthy at retirement age, you should plan for living into your 90s rather than relying on average life expectancy. Running out of money becomes a real risk without proper planning for longevity.

Missing out on penalty-free options

Several scenarios allow penalty-free early withdrawals, including:

• Unreimbursed medical expenses exceeding 7.5% of adjusted gross income
• Disability-related withdrawals
• First-time home purchases (up to $10,000 from IRAs)
• Birth or adoption expenses (up to $5,000)

Knowing these exceptions can save you money when unexpected situations arise.

Taking action

Making smart 401(k) withdrawal decisions affects how long your money lasts in retirement. Your approach to taking money from these accounts directly impacts both your tax bill and your financial security.

Just remember: Understanding the basic rules helps you avoid costly penalties. Traditional 401(k) withdrawals always trigger income tax, but waiting until age 59½ keeps you from paying the additional 10% early withdrawal penalty. You’ll also need to start taking required minimum distributions at age 73 to stay compliant with IRS rules.

Your withdrawal strategy matters more than you might think. The 4% rule offers a simple starting point, but proportional withdrawals from different account types often work better. This approach can extend your portfolio’s life and potentially save thousands in taxes.

Tax planning also makes a big difference. Rather than simply draining accounts in order, consider Roth conversions during low-income years. This strategy can protect you from the “tax torpedo” effect on Social Security benefits down the road.

Taking too much money early, underestimating how long you’ll live, or ignoring tax consequences can permanently damage your retirement security. Don’t forget about penalty-free withdrawal exceptions when you need flexibility. Your retirement strategy should change as your situation changes. Regular check-ins help ensure your withdrawal plan continues working for you. With careful planning, your 401(k) can provide the financial security you need throughout retirement.

Frequently asked questions

What is the recommended withdrawal rate for a 401(k) in retirement?

A common guideline is the 4% rule, which suggests withdrawing 4% of your total retirement savings in the first year and adjusting for inflation annually thereafter. However, personalized strategies based on your specific financial situation may be more effective.

How can I minimize taxes on my 401(k) withdrawals?

Consider using a proportional withdrawal strategy, taking money from different account types simultaneously. This approach can extend your portfolio’s life and potentially save thousands in taxes compared to withdrawing from accounts sequentially.

At what age can I start withdrawing from my 401(k) without penalties?

You can generally start withdrawing from your 401(k) without incurring the 10% early withdrawal penalty at age 59½. However, you’ll still owe income taxes on traditional 401(k) withdrawals regardless of your age.

Are there any exceptions for penalty-free early withdrawals from a 401(k)?

Yes, there are several exceptions for penalty-free early withdrawals, including disability, unreimbursed medical expenses exceeding 7.5% of your adjusted gross income, and qualified birth or adoption expenses up to $5,000.

How do Required Minimum Distributions (RMDs) work with 401(k)s?

RMDs begin at age 73 for traditional 401(k)s. The amount is calculated by dividing your account balance by a life expectancy factor provided by the IRS. Failing to take your RMD results in a penalty of 25% of the amount not withdrawn.

Can I take a loan from a SIMPLE IRA?

No, SIMPLE IRA plans do not allow participant loans from your plan account. This is a key difference from 401(k) plans, which may permit loans to participants under certain conditions.