Investing more in a 401k is one of the best ways you can accelerate your finance independence goals. But many people hold off because they’re concerned about needing the money before retirement. That’s a great reason to hold off if it were true, but it turns out there’s many ways to access your 401k so that you can save more in a tax advantaged way while still keeping your options open for the future.
Ways to access funds from your 401(k) early
- Roth Conversion Ladder
- Mega Backdoor Roth
- SEPP 72(t)
- Penalty
- Exceptions
1. Roth Conversion Ladder
This is a process that allows you to access money from your 401(k) with a five year delay.
When you retire (or leave your employer for another employer), roll your 401(k) into a Traditional IRA. This conversion can be done immediately with no penalties or tax implications.
Convert whatever amount you think you’ll need five years from now from the Traditional IRA to a Roth IRA. You’ll pay taxes on the amount you convert, so the best time to do this is in a year where your income is lower, such as when you’re taking a career break, this isn’t something you have to wait until retirement to do.
Then five years later, you can withdraw this converted money from your Roth IRA without paying any additional penalties or taxes.
2. Mega Backdoor Roth
This is the same process as above, just you can perform it while still being employed and actively contributing to a 401(k), you just need your employer to allow in-plan conversions. Rollover money from your after-tax 401(k) contributions to your Roth 401(k), then again to your Roth IRA, and then five years later, you can withdraw your contributions tax and penalty free. More details here: Mega Backdoor Roth.
3. SEPP 72(t) (Substantially Equal Periodic Payments)
SEPP 72(t) provides a structured way for individuals to withdraw funds from their 401k before reaching the standard retirement age, without incurring the typical early withdrawal penalty. Under this rule, you’re allowed to take substantially equal periodic payments based on your life expectancy or the joint life expectancy of you and your beneficiary. While this option can grant access to your retirement savings before the age of 59½, it’s important to note that the payment schedule must be followed strictly to avoid penalties.
4. Penalty
In most cases, withdrawing funds from your 401k before the age of 59½ leads to a 10% early withdrawal penalty in addition to regular income taxes. This penalty is intended to discourage people from tapping into their retirement savings prematurely. While we all want to avoid penalties, due to the significant tax advantages of the 401(k), investing with the mindset of taking the penalty can actually be a pretty effective strategy – See Final Totals in this article for a comparison of how paying the penalty can actually outperform other investment choices: How to Access Retirement Funds Early
5. Exceptions
Certain exceptions exist that allow penalty-free early withdrawals from a 401k. These exceptions typically cover situations such as medical expenses, permanent disability, higher education costs, or the purchase of a first home. While these exceptions might let you access your funds without the usual 10% penalty, income taxes on the withdrawn amount may still apply.
Conclusion
Hopefully you’re now confident that you can access investments from your 401(k) before age 59.5 and feel ready to divert money you were putting into a brokerage into a 401(k) to max out your tax benefits, more details on how 401(k)’s outperform brokerage accounts here: 401(k).