Early Withdrawal from Retirement Accounts: Penalties, Exceptions, and SEPP Plans for Business Owners
Retirement accounts (401(k), IRA, SEP IRA, SIMPLE IRA) are designed for long-term savings. Withdrawals before age 59 1/2 generally trigger two taxes: ordinary income tax on the distribution plus a 10% early withdrawal penalty under IRC 72(t). However, several exceptions allow penalty-free withdrawals (the income tax still applies, but the 10% penalty is waived).
Exceptions to the 10% early withdrawal penalty:
Applies to both IRAs and 401(k)s:
- Substantially Equal Periodic Payments (SEPP / 72(t) distributions): a series of substantially equal payments based on life expectancy, taken for at least 5 years or until age 59 1/2 (whichever is later)
- Disability (must be total and permanent, IRS definition)
- Death (distributions to beneficiaries)
- Medical expenses exceeding 7.5% of AGI
- IRS levy (to pay a federal tax debt)
IRA-only exceptions:
- First-time home purchase (up to $10,000 lifetime)
- Qualified higher education expenses
- Health insurance premiums while unemployed
- Birth or adoption expenses (up to $5,000 per child, SECURE Act)
401(k)-only exceptions:
- Separation from service in or after the year the participant turns 55 (the “Rule of 55”)
- Qualified domestic relations order (QDRO, for divorce)
- Hardship withdrawal (must meet IRS safe harbor requirements; the 10% penalty is waived only if the hardship qualifies under an IRC exception above, otherwise the penalty still applies but the plan allows the distribution)
How does SEPP (72(t)) work for business owners?
SEPP is the most commonly used exception for business owners who need to access retirement funds before 59 1/2. For current guidance, see IRS Retirement Plans for Small Business. It requires taking substantially equal periodic payments from the IRA or 401(k) based on one of three IRS-approved methods:
- Required Minimum Distribution (RMD) method: Divide the account balance by a life expectancy factor from IRS tables. The payment recalculates each year.
- Fixed amortization method: Amortize the account balance over life expectancy at a reasonable interest rate. The payment is fixed.
- Fixed annuitization method: Divide the account balance by an annuity factor from IRS mortality tables. The payment is fixed.
What about Roth accounts?
Roth IRA contributions (not earnings) can be withdrawn at any time, tax-free and penalty-free, because contributions were made with after-tax dollars. Only the earnings portion is subject to the early withdrawal rules. This makes Roth IRAs a more flexible emergency fund than traditional IRAs.
Roth 401(k) contributions follow different rules: they’re part of the 401(k) plan and subject to the plan’s distribution rules. However, rolling a Roth 401(k) to a Roth IRA starts the 5-year clock for tax-free earnings withdrawals.
When is the deadline to set up and fund a retirement plan for tax purposes?
Setup and funding deadlines vary by plan type. A SEP-IRA can be established and funded up to the tax filing deadline including extensions (October 15, 2026 for a sole proprietor who extends a 2025 return; an S corporation follows its own return’s due date). A solo 401(k) doesn’t have to be established by December 31: a plan adopted by the filing deadline, including extensions, can be treated as in place for the prior year, and employer contributions can be made until that deadline. Employee deferrals in an existing plan must be elected by December 31 (an S corporation owner’s come out of paychecks, so the election has to be in before the last one of the year); a sole proprietor can then deposit them by the filing deadline including extensions. In a plan adopted after year-end, first-year deferrals are open only to an unincorporated owner who is the business’s only employee, and the plan and the deferrals must be in by the unextended due date (April 15, 2026 for 2025). A SIMPLE IRA must be established by October 1 of the tax year. A defined benefit or cash balance plan can also be adopted up to the filing deadline including extensions, and its minimum required contribution is due 8.5 months after the plan year ends.
What if you skip contributions while drawing on retirement money?
For IRAs, a skipped year is lost. If you’re living off retirement savings and don’t make a 2025 IRA or Roth IRA contribution by April 15, 2026 (the date for most people, with no extension), you can’t make up that room in a later year. A contribution made after the deadline simply counts for the current year.
Business plans work much the same way for employee deferrals. In an existing Solo 401(k) or other 401(k), a deferral you didn’t elect by December 31 can’t be made for that year. The one exception is a sole proprietor with no employees who adopts a brand-new Solo 401(k) after year-end and makes first-year deferrals by the unextended return date, April 15, 2026 for 2025.
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SEP and 401(k) employer contributions for 2025 run to the business’s return due date with extensions, so there’s more time on that side.
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Yarik Yarosh, CPA. "Early Withdrawal from Retirement Accounts: Penalties, Exceptions, and SEPP Plans for Business Owners." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/small-business-retirement-account-early-withdrawal
This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.