Top 401k Early Withdrawal Exceptions for 2021 and Beyond

One of the most popular U.S. retirement plans is the 401(k). It seems as if each time I listen to the Dave Ramsey show, there’s usually a caller asking the question, “Should I use my retirement money to pay off debt?” There are consequences to doing this but also several 401K early withdrawal exceptions that you should know before considering taking your hard earned money out.

Retirement accounts

Before getting into specifics, I encourage you to stay up to date on the latest information regarding exceptions to tax on early withdrawals from retirement accounts. You can do so by visiting the IRS page.

401(k) plans and IRAs are now the most common way to save for retirement, and millions of Americans pour money into them every year.

Unfortunately, millions more take early withdrawals from these accounts due to:

  • hardship
  • loss of a job
  • paying for a house
  • higher education
  • medical expenses

On the flip side, many in the Financial Independence Retire Early (FIRE) community want to take the early withdrawals due to, you guessed it, retiring early.


The Basics

Any time you withdraw money from 401(k) plans and IRAs before age 59 1/2, you are subject to a 10% early withdrawal penalty. On top of that, income tax on the distributions are owed as well. Ouch!

There are thousands of Americans each year contemplating using their 401(k) accounts to bail them out of a financial crisis.

This has financial and retirement industry experts worried and rightly so. With today’s uncertain economy and consumer debt reaching record levels, more and more retirement plans are being tapped.

Unfortunately, a withdrawal taken in haste today could have a huge impact on your golden years.

401k Hardship

Unlike a 401k plan loan, a hardship withdrawal may be difficult to get, and costly if you receive it.

Knowing that workers would resist putting aside money for decades with no chance to access it, Congress made provisions in the 401k rules to allow plan withdrawals in a limited number of hardship situations. These include from 401khelpcenter.com:

  • Un-reimbursed medical expenses for you, spouse, or dependents.
  • Purchase of an employee’s principal residence.
  • Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
  • Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
  • For funeral expenses.

Remember, for most of the above early hardship withdrawals, our good friends at the IRS will impose a 10% penalty if you are younger than 59 1/2.

Penalty and taxes for early 401k withdrawl

Let’s do a little math to show you how much it would really cost someone that takes a hardship withdrawal.

Dr B loves to water ski. He’s had his eye on his neighbor’s ski boat that never leaves their carport and decides to make an offer (they can’t refuse). After the negotiations are complete, the two settle on a sales price of $10,000.


Feeling a little cash strapped, the good Dr decides to tap into his 401k which he’s never had to do before. Unfortunately, the $10,000 withdrawal does not equal $10,000 in his pocket.

Because he’s only 51 (under 59 1/2) he’s losing 35 to 45% of the withdrawal in taxes and penalties. Yikes!

If Dr. B is in the 28 percent tax bracket, he’ll owe:

  • $2,800 in federal income taxes ($10,000 x .28)
  • an additional $1,000 to cover the early 10% withdrawal penalty

After the deductions, he’s left with $6,300, or even less if he also owes state and local income tax.

Hopefully Dr. B thinks long and hard before he uses 401k funds to buy the boat.

Another way to think about this is, “Would he be willing to take out a loan with a 35-45% interest rate?” I’d think not.

How can you avoid paying a penalty for early withdrawl?

You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:


People with severe physical and mental disabilities who are no longer able to work (must obtain proof for IRS from a physician) can take distributions from both 401(k) plans and IRAs without being subject to the 10% penalty.

Medical Expenses

You may use Distributions from both IRAs and 401(k) plans used to pay for medical expenses not reimbursed by health insurance to avoid the 10 % penalty. These expenses must be greater than 10% of your adjusted gross income (AGI) in that year.

Court Order

You are required by court order to give the money to your divorced spouse, a child, or a dependent.

1st Time Home Purchase (IRA only)

The IRS considers someone to be a qualified first-time home buyer if you have not owned a home in the two years preceding the home purchase.

If you qualify, then you can withdraw up to $10,000 ($20,000 if married) from your IRA during your lifetime to buy or build a first home without being hit with the 10% penalty

Health Insurance (IRA only)

Withdrawals from IRAs used to pay health insurance premiums while unemployed are exempt from the 10% penalty if all the below requirements are met.

  • Unemployment compensation is received for at least 12 consecutive weeks.
  • The withdrawal is made the year unemployment compensation is received or the subsequent year.
  • The withdrawal must be made prior to 60 days of employment at a new job.
Education Expenses (IRA only)

You are able to avoid the 10% penalty if you choose to tap into your IRA to pay college expenses for:

  • yourself
  • spouse
  • child
  • grandchild (may need to ask pops to chip in! :))

The distribution can’t exceed the qualified higher education expenses incurred during the tax year. Qualified higher education expenses include:

  • tuition at a postsecondary school
  • room and board (if enrolled at least half-time)
  • fees
  • books
  • supplies
  • equipment required for enrollment or attendance


Members of the military reserves who take an IRA distribution during a period of active duty of more than 179 days avoid the 10% penalty. (Thank God for all of you that serve our great country!)


Distributions from both 401(k) plans and IRAs are exempt from the 10% penalty if they are rolled over into another eligible retirement plan within 60 days.

Disaster Relief

If your area is considered a disaster relief, then you maybe able to tap your 401(k) to pay for necessary expenditures.

My wife and I lucked up by leaving New Orleans only two short months before Hurricane Katrina struck.

Conclusion – Retirement Pain in the Butt

As you can see, there are many cases when you can potentially access retirement accounts early but it’s always a good idea to check with the IRS first before doing so.

One last point I want to touch on is what a hardship withdrawal can potentially do to your retirement.

Let’s revisit Dr. B. He has a friend Dr. A

Dr. A graduated from dental school at age 30.

He finds this blog (yeah!) and begins socking away $5,000 a year in his 401k. By the time he reaches age 40, he’s married with two kids and one on the way.

He arrives home one day to find his wife in a bit of a frenzy. She’s concerned that they are “running out of space” and need to get out of the cramped apartment they’ve been living in for the past three years. Bottom line: It’s time for a new home.

Dr A is a bit cash strapped and decided to take a $10,000 hardship withdrawal for the down payment. Let’s assume his portfolio has done well and has averaged roughly 8% a year.

When Dr A reaches 65, he will have $793,094. Had he not taken the hardship withdrawal he would have had $861,584, or $68,490 more.

A $10,000 withdrawal may seem insignificant today, but over time it can mean a lot.

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