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Is it time to plan for withdrawals from your 401(k)? Before you do, there are a few things to think about.

To withdraw from a 401(k), you’ll need to first contact your plan administrator to submit a distribution request, keeping in mind that early withdrawals generally incur penalties unless you qualify for an exception such as the Rule of 55.

While withdrawing from a 401(k) can initially seem like a complicated process, adequate planning can help it go more smoothly. Here’s what you need to know about initiating a 401(k) withdrawal and creating a smart retirement withdrawal strategy.

How to initiate a 401(k) withdrawal

Once you’ve decided to withdraw money from your 401(k) account, you’ll need to work with your plan administrator (often your employer’s HR department) to carefully consider what steps need to be taken.

• Log in to your employer’s 401(k) portal or contact your plan administrator
• Review your account balance and determine the amount you want to withdraw
• Complete the distribution request form (online or on paper)
• Review the form carefully, paying special attention to withdrawal type
• Submit the form and track processing through your plan portal

401(k) withdrawal options and consequences

There are several types of 401(k) withdrawals you can make. It’s important to understand your options, since the tax treatment and potential penalties are dependent on the withdrawal type.

Standard withdrawal (age 59 ½ or older)

Taxable 401(k) withdrawals made when you are at least 59 ½ years of age are usually taxed as ordinary income. Taking standard, periodic withdrawals is an ideal solution for retirees needing structured income without penalties.

However, you can also choose to take a lump-sum distribution, which is when you withdraw the entire balance of your 401(k) account within a single tax year. Lump-sum distributions are usually subject to a 20% mandatory tax withholding. Depending on your tax bracket, 20% may not be enough to cover your tax liability, so you can opt to have more than 20% withheld if that makes more sense.

Early withdrawal (before age 59 ½)

These withdrawals are also taxed as ordinary income, but they’re subject to an additional 10% tax, unless certain circumstances apply. The 10% tax penalty is meant to discourage plan participants from withdrawing funds from their 401(k) early, since early distributions can significantly reduce retirement savings. Distributions that are exempt from the additional tax include those that fall into the categories of: Distributions that are exempt from the additional tax include those that fall into the categories of:

• Total and permanent disability
• Terminal illness
• Qualified domestic relations order
• Medical expenses exceeding 7.5% of your adjusted gross income
• Internal Revenue Service levy
• Qualified reservist distributions
• Qualified birth or adoption (up to $5,000)
• Federally declared disaster
• Victims of domestic abuse
• Personal or family emergency expenses (up to $1,000)
• Separation of service from your employer in the year reaching the age of 55 or later

Note that the exceptions to the 10% tax aren’t all the same across retirement plan types, such as 401(k)s, IRAs, and SEP plans. For example, distributions from an IRA that are made for qualified higher education expenses are exempt from the 10% tax, while distributions made for this purpose from a 401(k) are not. The same goes for distributions of up to $10,000 made to purchase your first home. Certain withdrawals may allow for repayment within 3 years under the SECURE 2.0 Act.

Hardship withdrawal

Hardship withdrawals are made due to an immediate and heavy financial need and are for the amount necessary to satisfy that need. Distributions considered to have been made to address an immediate and heavy financial need include those for:

• Medical expenses
• Purchase of a principal residence
• Higher education expenses, including tuition payments
• Payments to prevent eviction from a principal residence
• Funeral expenses
• Certain expenses to repair damage to a principal residence

Hardship withdrawals are taxed as ordinary income and may be subject to the additional 10% tax penalty if you are under the age of 59 ½. These withdrawals permanently reduce your account balance, as you can’t repay them into your 401(k). Your employer must approve a hardship withdrawal, which is generally done by relying upon the employee’s written statement of financial need.

Rule of 55

The Rule of 55 refers to how employees who stopped working for their employer during or after the year they turned 55 are exempt from the 10% additional tax penalty from that employer plan. For public safety employees in a government-defined benefit or defined contribution plan, the applicable age is 50 instead of 55. The Rule of 55 applies only to the most recent employer 401(k) plan, not plans from previous employers.

401(k) loan

Depending on the rules outlined in your plan document, you may be permitted to borrow funds from your 401(k) plan. If your plan allows loans, the maximum you can borrow is $10,000 or 50% of your vested account balance – whichever is greater – up to a maximum of $50,000.

The loan isn’t taxable as long as you repay it, along with interest, within five years. However, an exception to the five years is if you use the loan to purchase your main home. You also must make regular payments, at least on a quarterly basis, to repay the loan. Some plans require you to repay the loan in full if you leave your job.

Comparing withdrawals

Here’s a quick look at how some of the common types of withdrawals stack up against each other.

Withdrawal strategies to help carry you through retirement

Advance planning of how you will go about withdrawing from your traditional 401(k) account can help you pay less in taxes over time and help you foresee if you might run out of funds in retirement. There are several considerations to make when taking distributions from your 401(k).

Manage your tax bracket

Because the IRS taxes taxable 401(k) distributions as ordinary income, it’s especially important to evaluate how withdrawing from your retirement account will affect the amount of taxes you owe. This is because large withdrawals made within a single year could potentially push you into a higher tax bracket.

Be mindful of Required Minimum Distributions in your 401(k)

Traditional 401(k)s have Required Minimum Distributions, meaning that you’ll be forced to withdraw from your retirement account once you reach a certain age, which is currently set at 73 for those born before 1960. This doesn’t mean that you have to withdraw on your 73rd birthday, however. You have until April 1 of the year after you turn 73 to take your first RMD. Note that if you keep working past the age of 73, RMDs won’t kick in until you retire. Also, for future reference, the new RMD age for those born in 1960 or after is 75.

It’s often advantageous to begin withdrawing from your 401(k) earlier than this and not to wait until RMDs kick in. This is due to the way RMDs are calculated, which is by dividing the account balance by a life expectancy factor. If you reach the age of 73 and haven’t withdrawn any funds from your 401(k), your RMDs could end up being fairly high, pushing you into a higher income tax bracket.

If you begin withdrawing earlier, let’s say when you hit the age of 59 ½, your withdrawals will be spread out more evenly over time, which generally has favorable tax implications. In this situation, your 401(k) balance will be lower once RMDs kick in, so the distributions won’t be as high.

If you don’t take RMDs, you will be penalized. The amount of your RMD that you didn’t withdraw by the due date is subject to a 25% tax. However, if you correct the RMD within two years, the penalty falls to 10%. The only way to avoid the penalty if you fail to withdraw the full amount of your RMD is if you can prove that the shortfall was made due to “reasonable error” and that you’re taking steps to correct this error.

Annual vs. monthly withdrawals

A common debate regarding 401(k) withdrawals is whether you should take distributions on a monthly or annual basis. This applies to both RMDs and other withdrawal types, and there are some advantages and disadvantages to each timing option.

Retirees who choose to withdraw funds on an annual basis usually take their annual withdrawal at either the beginning or the end of the year. One of the main appeals of withdrawing annually is the simplicity of this strategy. Also, if you’re planning to make a major purchase, withdrawing a large amount all at once can help to make this possible.

On the other hand, monthly or quarterly withdrawals are also popular. Withdrawing throughout the year rather than all at once can help with cash flow management, providing a steady income throughout the year.

The implications of either strategy depend on the particulars of the withdrawal timing. For instance, let’s say that you withdraw annually at the end of the year. By delaying withdrawal until the end of the year, you’re giving your money more opportunity to grow in your 401(k). In this case, annual withdrawals could be preferable to quarterly withdrawals.

However, if you withdraw funds annually at the beginning of the year, the effects are reversed. Your money has less opportunity to grow in your account, and in this case, taking monthly withdrawals provides more growth potential.

Something else to note about monthly withdrawals is that you don’t have to take out the same amount each month. For instance, if during one month you need more funds for a home or car repair, you can take a higher withdrawal and then adjust the amount for the remaining months.

Consider other income sources

For most retirees, their 401(k) isn’t their only source of retirement income. In retirement, you might also have income from Social Security, IRAs, pension plans or regular brokerage and savings accounts. Factoring in all your retirement income, including RMDs, can help you calculate exactly how much you need to withdraw from your 401(k) and can also aid in tax planning.

The traditional approach is to withdraw from one account at a time during retirement, in the following order:

• Taxable accounts (checking and savings accounts, brokerage accounts, employer stock purchase plans)
• Traditional accounts (traditional IRA, traditional 401(k), traditional 403(b))
• Roth accounts (Roth IRA, Roth 401(k) and health savings accounts)

The reasoning behind this strategy is that by withdrawing from taxable income accounts first, you’re giving your traditional and Roth accounts more time to grow tax-free. However, in some situations, the optimal strategy could be to withdraw proportionally from each of your accounts every year instead of withdrawing from one account at a time. In this case, the tax impact would be evenly spread out over time, and overall taxes in retirement could potentially be lower than the traditional approach.

The 4% rule

If you’re looking for a simplified rule of thumb to follow for 401(k) withdrawals, one common strategy is to follow the 4% rule. To follow this rule, you would withdraw 4% of your retirement balance during the first year of retirement. In subsequent years, you would adjust the percentage for inflation. The idea is that if you follow this rule, your retirement fund should last approximately 30 years.

The 4% rule may not be the best guidance for all retirees, though. Those expecting their retirement to last longer than 30 years, such as those retiring early, may need to withdraw less than 4% annually for their funds to last. Also, in some situations, the 4% rule may be too conservative, and certain retirees may be able to withdraw larger amounts without running out of money.

Convert to a Roth IRA

Depending on your financial situation, you may find it beneficial to convert some or all of your traditional 401(k) to a Roth IRA or Roth 401(k). This can be an appealing strategy for a couple of reasons. First, unlike withdrawals from a traditional 401(k), Roth withdrawals are tax-free. Second, there are no required minimum distributions with a Roth. However, you’ll have to pay taxes on any amount you convert from your 401(k) to the Roth account.

Build a withdrawal strategy that works for you

There’s no one-size-fits-all approach to 401(k) withdrawals. The right strategy depends on factors such as your tax situation, other sources of retirement income, life expectancy and long-term financial goals. By planning withdrawals thoughtfully and coordinating them with the rest of your retirement assets, you may be able to reduce taxes, create more predictable income and help your savings last longer. Explore more retirement income, tax planning and withdrawal strategy resources from ��Ѩ��Ƶ, and speak with your plan administrator, a tax professional and a financial advisor to help build a plan tailored to your unique needs.

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