Is that Early Pension Withdrawal Worth It?

April, 18 2025 by Carolyn Richardson, EA, MBA

There’s a saying that when the going gets tough, the tough get going. And at least in the U.S., where the security net for unexpected unemployment, health or medical expenses, and unforeseen emergencies is a little thinner than in other countries, it can seem like when the going gets tough, Americans get going…straight to their retirement accounts. For many Americans, a retirement account may be their only significant savings against a rainy day. Let’s face it – Americans are terrible when it comes to saving money for an emergency fund, even though financial experts recommend having enough money in the bank to cover three to six months’ worth of expenses. But when you’re living paycheck to paycheck, that can be hard to set aside. According to U.S. News and World Report, 42% of Americans do not have any emergency funds, and nearly 40% could not cover a $1,000 emergency expense with cash or savings.

This can make the money that you’ve been contributing to your 401(k) account awfully tempting to use when you are cash-strapped, and most employer plans allow participants in the plan to withdraw or borrow against the funds they have saved. If you have an IRA, it’s even easier to withdraw funds since that is entirely within your control and not subject to some of the limitations that an employer plan might have in place. However, withdrawing from your pension or IRA accounts can have unexpected consequences, both when it comes to your taxes and for your overall financial health in retirement. Let’s take a look.
 

Can you withdraw funds?

While you may have heard that you can withdraw funds from your retirement account due to financial hardship, that doesn’t mean you can withdraw them without tax consequences.

First of all, many employer plans may not have provisions for allowing a distribution, even if you are facing financial hardship. Whether you can withdraw money from your plan will depend on how the plan is set up, and it is best to consult with your human resources department to find out if this is even an option. Also, hardship withdrawals may be limited by law to such things as needing the funds for college tuition for yourself or a dependent, distributions to avoid foreclosure or eviction from your place of residence, funeral expenses, unforeseen medical expenses, or for a down payment or repairs to your home. The IRS rules also govern how much can be withdrawn for these reasons. The money may not be available immediately, either. It can typically take 7-10 business days to withdraw funds from an employer plan, although that can vary.

With an IRA account, you can receive the funds much faster as all you generally need to do is contact the financial institution holding the money and ask for it. But you may not have enough in an IRA to cover the expense you are withdrawing the funds for. And, if you are withdrawing the funds from a traditional IRA rather than a Roth IRA, there are substantial tax consequences if you do not meet certain age requirements. A bit more on that later.

Whether you are withdrawing funds from an IRA or an employer retirement account, if the money that has been put into that account was “pre-tax” money, which is typical of traditional IRAs and most employer plans like 401(k) or 403(b) plans, then withdrawing that money means you will have to pay taxes on it when you withdraw the funds. If you are withdrawing from a Roth IRA or a designated Roth account in an employer plan, some of the funds may be tax-free, but the earnings on those funds generally are not tax-free unless you meet time and age requirements.
 

Withdrawing Retirement Funds

Whether withdrawing from your retirement funds is a smart idea can depend on several factors. First is your age. Are you at least 59½ years of age, which is the minimum age for not having to pay the 10% early withdrawal penalty? Both IRA and employer account distributions are subject to this penalty if you are not at least 59½ when you withdraw the funds. Another factor to consider is your typical tax rate on your other income. While the IRS does allow hardship withdrawals from retirement accounts, any distribution of pre-tax dollars from these accounts is subject to regular income tax rates. Distributions from a Roth or designated Roth accounts in an employer plan can also be taxable if the account was not established at least 5 years prior to the withdrawal. Tax rates vary from 10% to 37%, so depending on your tax bracket, the amount of tax that you pay on your withdrawal can add substantially to your tax bill for the year, particularly if you are also subject to the 10% early distribution penalty. And because the funds are taxed as regular income, they can also push you up into a higher bracket than you normally pay.

For example, let's say that you are in a 20% marginal tax bracket, are 50 years old, live in a state where your state income tax rate is 5%, and decide to withdraw $50,000 from your retirement account. This $50,000 would be subject to the 10% early withdrawal penalty, or $5,000. You would also owe an additional $10,000 in federal income taxes and $2,500 in state income taxes (and some states also charge an early distribution penalty!). So, as a result of withdrawing this money, your tax bill on this $50,000 distribution would be an additional $17,500, or 35% of the amount that you withdrew!

That's a hefty price tag to pay. Especially if you have spent all of the distribution without considering the tax costs and putting aside money for the potential tax liability. While employers and financial institutions will typically withhold at least 10% on an early distribution, that withholding would only cover the penalty amount but not the income taxes due. Would you even be able to pay your tax liability? If you withdrew the money because of a financial hardship, you have essentially exchanged one financial hardship with a new one, now owed to the IRS and your state tax department. And they tend to be far less forgiving than most creditors.

Even without a large tax bill as a consideration, withdrawing money from an employer account means you will also lose out on any employer matching contributions, which can significantly reduce your retirement funds by the time you retire due to the loss of the compounded growth. Many employer funds also will not permit you to contribute to your retirement account for a period of time if you withdraw funds early, losing out on the growth of the money you could have contributed otherwise.
 

Alternatives to Withdrawing Funds Early

Many employer plans provide for loans from your retirement account rather than taking distributions, and a loan would be nontaxable at the time it is obtained. While it is best not to touch the funds in your retirement account entirely, if your employer provides for a loan from your retirement account, that may be a better option than a distribution. Loans generally can be provided to you within a matter of days, and payments are typically handled through payroll deductions, making repayment easy (although it may not be painless, as your take-home pay will be reduced by the loan repayment). Loans generally need to be paid back in full within 5 years, but, if you are using the loan to purchase a home, you can repay the loan over as long as 10 years. On the plus side, you are paying the money back to your own retirement account. Essentially, this means that you are borrowing money from yourself and paying money back to yourself, with interest. This is a good option if you expect your employment prospects with the company to last for a significant period of time or at least as long as it will take to repay the loan. Keep in mind, however, that if you leave your company or are terminated or laid off before the loan is paid off, the outstanding balance of the loan can be treated as a distribution by your employer in the year your employment ends. That could be several years after you received the loan money, and if you borrowed a significant amount, the same tax consequences apply to a “deemed” distribution from a defaulted loan. And if that is the case, then the same rules apply as early distribution where you will owe additional taxes and the 10% penalty if you are under the age threshold.

There may be other options available. If you have a Roth IRA account, you can withdraw your principal (the amount you originally contributed) in the Roth IRA tax-free if you are at least 59½ years old and your first deposit to the account was at least five years ago. Even if you are under 59½, you can still withdraw the amount you contributed to the account originally tax free – although, if you are below the age threshold, any earnings or dividends that you withdraw from your Roth IRA account are subject to the 10% penalty and are not tax-free. Many of the same exceptions that apply to regular IRA distributions also apply to Roth distributions, such as paying for a first home or higher education. If you want more information on the exceptions to the penalties, you can check the IRS website at irs.gov.

If you own your own home and have equity in that home, a home equity line of credit (HELOC) might be a better option to obtain cash without the same problems and consequences as an early withdrawal from your retirement plans. While a HELOC can take 30 days or more to get in place, if you don't already have one (it is essentially a second mortgage), once established it gives you a revolving line of credit that you can pull from for the duration of the HELOC’s term, which is typically 10 years. And you generally have another 10 years to pay off the HELOC, maybe even longer, depending on the loan terms. There is also more flexibility in what you borrow the money for and how much you borrow, unlike a retirement plan. And because this is a loan, there is no 10% early distribution penalty. Another option if you own your home might be a home equity loan for a lump sum payment or even doing a cash-out refinancing, rather than a revolving loan like a HELOC.

If you just need a small amount of money, such as for car repairs, check with your financial institution to see if a personal loan through one of those institutions may also be an option. You may need to have a good credit rating for this option, but if you have a long-term relationship with your financial institution, they may be willing to lend money even if your credit isn’t stellar. While the interest rates on personal loans from your bank may seem high, it is very likely they are less than what you will pay in taxes on a retirement distribution. Another short-term loan option might be borrowing money from friends or family to get you over the financial hump.
 

Be Smart – Look at the Big Picture

Being short on cash can be stressful for anyone. If you have truly gotten yourself into a hole that you don’t think you can dig out of, negotiating with your creditors to reduce your balances due or extend the time for paying them off can be done, and consumer credit counselors can walk you through the process. You may even need to consider bankruptcy if your financial situation is truly hopeless. At least in most bankruptcies, you can keep your retirement accounts intact as creditors generally cannot request that those funds be used to pay off debts in bankruptcy. You should consult with an attorney who specializes in this area of the law if you are contemplating such a thing.

When it comes down to it, the high costs of withdrawing money early from your retirement accounts, both immediately in tax consequences and in the long-term picture of planning for your retirement, make withdrawing money from these accounts a bad idea. These accounts should be the last place you look to find money to get you out of a financial bind.