Early Withdrawals

Money in a 401(k) or IRA was never taxed. Take it out and it is ordinary income, at whatever bracket you are in that year. Take it out before age 59½ and there is a second charge: a 10% additional tax on the amount, on top of the income tax. On a $20,000 withdrawal in the 22% bracket, that is $4,400 of income tax plus $2,000 of penalty plus Colorado’s $880, and the plan withheld $4,000, so $3,280 is still due in April. People are surprised by that every year.

The penalty has exceptions, and Congress has added several since 2020. Some apply only to workplace plans, some only to IRAs, and some to both. Below is the list, the one that is misunderstood most (the 55 rule), the Roth rules that let you take contributions back at any time, and the form that claims the exception, because the plan will not claim it for you.

What You Actually Pay

The IRS calls it: Section 72(t), additional tax on early distributions

Three things happen when you take $20,000 out of a traditional 401(k) at 45. First, the $20,000 is added to your income for the year and taxed at your rate. Second, 10% of it, $2,000, is added as a penalty. Third, the plan withholds 20% because the money could have been rolled over, and sends you $16,000. The $4,000 withheld feels like the tax was handled. It covers the income tax at 22% only if nothing else changed, and it never covers the penalty or Colorado. The balance shows up in April.

An IRA custodian withholds 10% by default unless you tell it otherwise. That is worse: on the same $20,000 in the 22% bracket, $2,000 is withheld and about $5,280 is due. If you must take money early, ask for more withholding than the default; Form W-4R lets you pick the percentage.

There is no penalty on the earnings portion of a 401(k) withdrawal separately; the whole distribution is one number. The exceptions below remove the 10%. None of them removes the income tax.

Exceptions for Plans and IRAs Alike

The IRS calls them: Section 72(t)(2) exceptions

Exception	What it requires	Limit
Age 59½	The distribution is on or after the day you turn 59½	None
Death	Paid to a beneficiary or the estate	None
Disability	Total and permanent, unable to do any substantial work, expected to last indefinitely or result in death	None
Medical expenses	Unreimbursed medical costs above 7.5% of AGI in the year of the withdrawal; you don’t have to itemize	The excess over 7.5%
Substantially equal periodic payments	A series of annual payments figured by an IRS method; must continue 5 years or to 59½, whichever is later	The computed amount, no more, no less
IRS levy	The IRS takes it directly to satisfy a tax debt	The levied amount
Birth or adoption	Within one year after the birth or adoption; may be repaid within 3 years	$5,000 per child, per parent
Terminal illness	A physician certifies death reasonably expected within 84 months; may be repaid within 3 years	None
Emergency personal expense	You self-certify an unforeseeable or immediate financial need; one per year; no second one for 3 years unless the first is repaid	$1,000
Domestic abuse	Within one year of abuse by a spouse or partner; self-certified; may be repaid within 3 years	Lesser of 50% of the account or $10,000 indexed (about $10,500 for 2026 (verify))
Federally declared disaster	Principal residence in the disaster area and economic loss; income may be spread over 3 years; may be repaid	$22,000 per disaster
Military reservists	Called to active duty for more than 179 days	None

The repayment feature on several of these is worth knowing: if you put the money back within three years, you amend and get the income tax back too. The emergency and domestic-abuse exceptions were added by the SECURE 2.0 Act, and employer plans may choose not to offer them; IRAs always can.

Exceptions Only Workplace Plans Get

The IRS calls it: separation from service, and QDROs

The 55 rule. If you leave your job in or after the year you turn 55 (50 for police, firefighters, EMTs and certain federal employees), withdrawals from that employer’s plan carry no penalty. The money has to stay in the plan; roll it into an IRA and the exception disappears, because IRAs don’t have it. This is the one most often mishandled. A 56-year-old laid off with $400,000 in a 401(k) can draw on it penalty-free for the next three and a half years. The same person who rolls it to an IRA the week after leaving, on a broker’s advice, has just locked it up until 59½.

It applies to the plan you separated from, not to a 401(k) from a job you left at 50. And “the year you turn 55” means a January separation at 54 works if your 55th birthday is in December.

QDRO distributions. Money paid to a former spouse under a qualified domestic relations order, taken directly from the plan, is penalty-free to the former spouse at any age. Covered on the divorce page.

Dividends on employer stock in an ESOP, and certain distributions of excess contributions, are also exempt; those are rare.

Exceptions Only IRAs Get

The IRS calls them: Section 72(t)(2)(E), (F) and (D)

• Higher education. Tuition, fees, books, supplies, and room and board for a half-time student, for you, your spouse, your children or grandchildren, paid in the same year as the withdrawal. No dollar limit beyond the expenses. Note that the withdrawal is still income, which can reduce financial aid the following year.
• First home. Up to $10,000, once in a lifetime, used within 120 days to buy or build a main home for you, your spouse, a child, grandchild or parent. “First-time” means no ownership interest in a main home in the prior two years, so it can be a second first home.
• Health insurance while unemployed. Premiums paid after you have received unemployment compensation for 12 consecutive weeks, through the year after.

None of these three works from a 401(k). People roll the 401(k) to an IRA first, then take the withdrawal, and the order matters.

Roth: Your Contributions Come Back Free

The IRS calls it: the ordering rules, Section 408A(d)(4)

A Roth IRA is the exception to all of the above, in one direction. Money comes out in a fixed order: contributions first, then conversions (oldest first), then earnings. Your own contributions were already taxed, so they come back with no tax and no penalty at any age, for any reason. If you put $40,000 into a Roth over the years and it is now worth $65,000, the first $40,000 out is yours, free.

Converted amounts are the trap: each conversion has its own five-year clock, and taking converted money out within five years, before 59½, triggers the 10% penalty on it (not the income tax, which was paid at conversion). Earnings come out last and are taxable and penalized before 59½ unless the account is five years old and an exception applies.

Roth 401(k)s do not follow the ordering rules; a withdrawal is pro-rated between contributions and earnings. Roll it to a Roth IRA first if you need the flexibility.

Let me see if I have this right. The account with the tax already paid is the one I can touch. The one with the tax still owed is the one I can’t. I’d have planned differently at 30.

Loans, Hardship, and the 60-Day Trap

What is not a distribution, and what quietly becomes one

A 401(k) loan is not a distribution. Up to $50,000 or half your balance, repaid through payroll over five years, no tax, no penalty, and the interest goes back to you. It becomes a distribution the day you stop repaying, which usually means the day you leave the job. Since 2018 you have until the due date of that year’s return to repay the balance into an IRA; miss it and the whole outstanding loan is income plus 10%. IRAs cannot make loans at all.

A hardship withdrawal is the opposite of what it sounds like. The plan lets you take the money for medical bills, a home purchase, tuition, eviction or funeral costs. The IRS still charges the 10% unless one of the exceptions above independently applies. Hardship gets the money out; it does not make it penalty-free.

The 60-day rollover. Money paid to you from a plan or IRA can be put into another account within 60 days with no tax. One such rollover per 12 months for IRAs. People use it as a short loan and miss the deadline by a week; the result is income, penalty, and no way back. Direct transfers, custodian to custodian, have no deadline and no limit and are the safer route.

Form 5329: Claiming the Exception

The plan reports a code 1; you report a code 2

The 1099-R you receive has a distribution code in box 7. Code 1 means “early, no known exception,” and that is what most plans put on every withdrawal before 59½, including the ones that qualify. Code 2 means the payer knows an exception applies; you will see it on QDRO payments and some 55-rule plans. Code 7 is normal.

If your 1099-R says 1 and you qualify for an exception, nothing happens unless you file Form 5329 with your return and enter the exception number on line 2. The software will not do it on its own, and many self-prepared returns pay a penalty they didn’t owe. If you paid one in a prior year, it can be claimed back by amending within three years.

A Worked Example

Colorado

Colorado taxes the withdrawal as ordinary income at 4.40%, since it is in federal taxable income. Colorado has no penalty of its own; the 10% is federal only. The pension and annuity subtraction can help: at 55 to 64, up to $20,000 of retirement income per person is subtracted, and IRA and 401(k) distributions count as retirement income. A 56-year-old taking $40,000 pays Colorado tax on $20,000 of it. Under 55 there is no subtraction except for a beneficiary. The Colorado retirees page has the full rules, including the income limit that applies at 65.