How much can i draw from my 401k

For many Americans, the balance of their 401(k) account is one of the biggest financial assets they own -- but the money in these accounts isn't always available since there are restrictions on when it can be accessed.

401(k) plans are meant to help you save for retirement, so if you take 401(k) withdrawals before age 59 1/2, you'll generally owe a 10% early withdrawal penalty on top of ordinary income taxes.

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However, there are limited exceptions. For instance, if you incur unreimbursed medical expenses that exceed 10% of your adjusted gross income, you can withdraw money from a 401(k) penalty-free to pay them. Similarly, you can take a penalty-free distribution if you're a military reservist called to active duty.

Because the exceptions are narrow, most people must leave their money invested until 59 1/2 to avoid incurring substantial taxes. However, there is one big exception that could apply if you're an older American who needs earlier access to your 401(k) funds. It's called the "rule of 55," and here's how it could work for you.

What is the rule of 55?

The rule of 55 is an IRS regulation that allows certain older Americans to withdraw money from their 401(k)s without incurring the customary 10% penalty for early withdrawals made before age 59 1/2. The rule of 55 applies to you if:

• You leave your job in the calendar year that you will turn 55 or later (or the year you will turn 50 if you are a public safety worker such as a police officer or air traffic controller). You can leave for any reason, including because you were fired, you were laid off, or you quit.
• You are withdrawing funds only from a 401(k) account offered by your most recent employer. You cannot withdraw money penalty-free from accounts with other past employers, nor can you make penalty-free withdrawals from an IRA, even if you rolled over your 401(k) into one upon leaving your most recent job.

One common misconception is that you can leave your job before the calendar year you turn 55 and the rule will still apply to you. This is not the case. If you are turning 55 in 2022 and left your job on Dec. 31, 2021, the rule does not apply to you.

How to make the best use of the rule of 55

The restrictions of the rule of 55 make it vital to use smart retirement planning techniques. First and foremost, you need to time your early retirement so you don't leave your job before the year in which you'll turn 55.

Second, if you want to maximize the amount of money you can withdraw without penalties, you should take advantage of rollover options to move as much money as you can into your current employer's 401(k) before leaving your job. For example:

• Many companies allow you to roll over 401(k)s from previous employers into your new employer's account.
• Many also enable you to move money from an IRA into your workplace 401(k) if the money got into the IRA when you rolled over a former workplace 401(k).

Any money in your current employer's 401(k) account when you leave your job will qualify for the rule of 55, so using rollovers to put as much money into that account as possible provides you with the most flexibility. If you don't roll the money from old 401(k)s or rollover IRAs into your current 401(k) before leaving, you won't have the option to withdraw without penalty until age 59 1/2.

Finally, remember not to roll over your eligible 401(k) account into an IRA after quitting at age 55 or older. Doing so will cause you to lose the exemption and subject you to penalties for withdrawals until you hit 59 1/2.

Having access to money is vital for retirees, especially if you end up having to retire early or unexpectedly. Knowing the rules about getting access to your 401(k) at 55 or older can be a lifesaver for your finances.

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401(k)s are incentivized plans to help Americans save for retirement. The government provides tax breaks to encourage you to contribute, but it also enforces certain rules to discourage you from taking distributions before retirement. In some cases, breaking those rules and taking distributions early can cost you a 10% penalty in addition to the ordinary income taxes you'll owe on withdrawn funds. 

Let's look at all the approved ways you can take money out of a 401(k) and look into the penalties you'll incur if your early distributions don't fall within one of those exceptions. 

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There are many different ways to take money out of a 401(k), including:

• Withdrawing money when you retire: These are withdrawals made after age 59 1/2. 
• Making an early withdrawal: These are withdrawals made prior to age 59 1/2. You may be subject to a 10% penalty unless your situation qualifies as an exception. 
• Making a hardship withdrawal: These are early withdrawals made because of immediate financial need. You may be still be penalized for them. 
• Taking out a 401(k) loan: You can borrow against your 401(k) and will not incur penalties as long as you repay the loan on schedule. 
• Rolling over a 401(k): If you leave your job, you can move your 401(k) into another 401(k) or IRA without penalty as long as the funds are moved over within 60 days of your distribution. 

Withdrawing when you retire

After you reach the age of 59 1/2, you may begin taking withdrawals from your 401(k). If you leave your job in the calendar year when you turn 55 or later, you can also begin taking penalty-free withdrawals from the 401(k) you had with that current company. If you are a public safety worker, this rule takes effect at the age of 50. 

Once you reach 72, you are actually obligated to begin making required minimum distributions or RMDs. 

Early withdrawals

Any withdrawal you make prior to age 59 1/2 is considered an early withdrawal. In most cases you are subject to a 10% penalty for any early withdrawal, in addition to the ordinary income taxes you always owe when taking money out of a 401(k). However, there are a few exceptions:

• Rule of 55: This applies if you leave your current employer in the calendar year you turn 55 or later and take money from that company's 401(k) only. 
• Substantially equal periodic payments: These require you to withdraw a certain amount from your account for at least five years or until you reach 59 1/2 (whichever is later). 
• Permanent disability: This applies if you meet your employer plan's definition of "disabled."
• Qualifying medical expenses: If your expenses exceed a certain percentage of your adjusted gross income, you can withdraw funds penalty-free to cover them. 
• Qualified domestic relations order: If a court orders you to give 401(k) funds to a spouse or dependent, you can withdraw the money penalty-free.  

Hardship withdrawals

Some 401(k) plans allow you to take early withdrawals when you experience an "immediate and heavy" financial need. Some examples include:

• Medical expenses
• Costs associated with purchasing a primary home
• Tuition payments or other qualifying educational expenses for the 401(k) owner, his or her spouse, or dependents
• Payments necessary to prevent eviction or foreclosure
• Burial or funeral expenses for a parent, spouse, child, or other dependent

Even if your employer's plan permits hardship withdrawals, you may still be subject to the 10% early withdrawal penalty unless you fall within one of the above exemptions. 

401(k) loans

Some plans allow you to borrow up to 50% of your vested account balance to a maximum of $50,000 within a 12-month period. 

A 401(k) loan operates much like a standard loan -- you will have to pay back the borrowed funds with interest. If you default on repayment, it will be considered a distribution, and you could be subject to the 10% penalty for early withdrawals.

Rolling over a 401(k)

If you leave your job or your plan terminates, you can roll over the 401(k) funds to another tax-advantaged retirement account. 

You may be able to do a direct rollover, which means the money moves from your 401(k) right into your new tax-advantaged account. You can also do an indirect rollover, in which you receive the funds directly and deposit them in your new account within 60 days to avoid treatment as a distribution. 

When you leave a job

When you leave a job, you generally have the option to:

• Leave your 401(k) with your current employer
• Roll over the funds to an IRA
• Roll over the funds to your new employer's 401(k).

If you choose any of those options, you will not owe taxes or a 10% penalty. You can also take this money as a distribution, but this will trigger early withdrawal penalties if you are under 59 1/2 (unless the Rule of 55 applies). 

Rollover to an IRA

Rolling a 401(k) over into an IRA is often a good option when you leave your job or your plan terminates. You can open an IRA with any brokerage and generally have a wider choice of investment options. You may have the option of a direct or indirect rollover.

You must roll over a traditional 401(k) to a traditional IRA to avoid owing taxes. If you wish to instead do a Roth conversion, there will be tax consequences. 

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