Understanding 401(k) Withdrawal Rules

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A 401(k) plan is an employer-sponsored retirement account that allows employees to contribute a portion of their paychecks before IRS tax withholding. Companies usually match a percentage of the employee’s contribution and add it to the 401(k) account.

Before age 59½, an employee faces an IRS penalty if they withdraw money from a 401(k) account. The IRS allows penalty-free withdrawals, called qualified distributions, from retirement accounts after age 59½.

At that point, individuals will also be allowed to convert their company-sponsored 401(k) into a more flexible individual retirement account (IRA). Withdrawals from a 401(k) are required after age 73 or 75, depending on the year you were born, and are called required minimum distributions, or RMDs.

Key learning points

  • If you retire after age 59½, you can withdraw money without paying an early withdrawal penalty.
  • If you don’t need access to your savings just yet, you can leave them, although you won’t be able to contribute then.
  • To continue contributing, you must transfer your 401(k) to an individual retirement account (IRA) and have earned income that you can add to the account.
  • With both a 401(k) and a traditional IRA, you must make minimum distributions starting at age 73 or 75, depending on the year you were born.

401(k) Withdrawals after age 59½

There are tax-advantaged retirement accounts, such as 401(k)s, to ensure you have enough income when you get old, retire, and no longer receive a steady paycheck. From time to time you may like to tap into your money before you retire; however, if you succumb to those temptations, you will likely pay a heavy price, including early withdrawal penalties and taxes such as federal income tax, a 10% penalty on the amount you withdraw, and relevant income taxes.

Most Americans retire in their mid-sixties. A little more flexibility is offered with retirement savings plans, including the company-sponsored 401(k). The Internal Revenue Service (IRS) allows you to start taking distributions from your 401(k) without a 10% early withdrawal penalty once you are 59½ years old.

If you retire — or lose your job — when you’re 55 but not yet 59½ years old, you can avoid the 10% early retirement penalty for withdrawing money from your 401(k); however, this only applies to the 401(k) from the employer you just left. Money left in a previous employer’s plan doesn’t qualify for this exception, nor does money in an IRA.

How to Take 401(k) Distributions

Depending on your company’s rules, you can choose to take out regular annuity payments, for a fixed period of time or over your expected lifespan, or make non-recurring or one-off withdrawals.

When you take distributions from your 401(k), the remainder of your account balance remains invested according to your previous allocations. This means that the period over which payments can be made and the amount of each payment depend on the performance of your investment portfolio.

Taxes on 401(k) distributions

If you take qualified distributions from a traditional 401(k), all distributions are subject to ordinary income tax. Contributions were taken from your paycheck before they were taxed, delaying the tax process until the withdrawal date. In other words, when you eventually tap into your traditional 401(k) funds, distributions for that year are treated as taxable income, on top of any other money you’ve earned.

On the other hand, if you have a designated Roth account, you’ve already paid income tax on your contributions, so withdrawals aren’t subject to tax. Roth accounts also allow income to be distributed tax-free as long as the account holder is over 59½ and has held the account for at least five years.

Keep your money in a 401(k).

You do not have to withdraw benefits from your account when you retire. While you can’t continue to contribute to a 401(k) from a previous employer, if you’ve invested more than $5,000, your plan administrator must keep your plan. Anything less than $5,000 will likely result in a lump sum payment.

If you don’t need your savings right after you retire, there’s no reason to stop using your savings as investment income. As long as you are not receiving distributions from your 401(k), you are not subject to any tax.

If your account has $1,000 to $5,000, your company is required to transfer the money to an IRA if it forces you out of the plan, unless you choose to receive a lump sum payment or transfer the money to an IRA of your choice.

Required minimum distributions

While you don’t have to start taking distributions from your 401(k) as soon as you retire, you must start taking required minimum distributions (RMDs) when you turn 73 if you were born between 1951 and 1959 , and 75 if you were born in 1960 or later. The age was previously 72 before Congress passed SECURE 2.0 in December 2022.

If you wait to withdraw your RMDs, you should start withdrawing regular, periodic distributions that are calculated based on your life expectancy and account balance. While you can withdraw more in any given year, you cannot withdraw less than your RMD.

Converting a 401(k) to an IRA

You can’t contribute to a 401(k) after you leave your job, so if you want to keep adding money to your retirement funds, you’ll need to transfer your account(s) to an IRA. Previously, you could contribute to a Roth IRA indefinitely, but you could not contribute to a traditional IRA after age 70½; however, under the new Setting Every Community Up for Retirement Enhancement (SECURE) Act, you can now contribute to a traditional IRA for as long as you like.

Keep in mind that you can only contribute earned income, not gross income, to any type of IRA, so this strategy only works if you haven’t fully retired and are still earning “taxable compensation” such as wages, salaries , commissions, tips, bonuses or net self-employment income,” as the IRS puts it. You cannot contribute money earned from investments or your Social Security check, although certain types of alimony payments may be eligible.

To rollover your 401(k), you can ask your plan administrator to distribute your savings directly to a new or existing IRA. You can also choose to make the payment yourself; in this case, however, you must deposit the money into your IRA within 60 days to avoid paying taxes on the income.

Traditional 401(k) accounts can be transferred to a traditional IRA or a Roth IRA, while designated Roth 401(k) accounts must be transferred to a Roth IRA.

Traditional IRA vs Roth IRA

Like traditional 401(k) distributions, withdrawals from a traditional IRA are subject to your regular income tax rate in the year you make the distribution.

Withdrawals from Roth IRAs, on the other hand, are completely tax-free if taken after you reach age 59½ (or follow a five-year period, whichever is later); however, if you decide to transfer the assets in a traditional 401(k) to a Roth IRA, you’ll owe income tax on the full amount of the rollover — with Roth IRAs, you pay taxes up front.

Traditional IRAs are subject to the same RMD regulations as 401(k)s and other employer-sponsored retirement plans; however, there is no RMD requirement for a Roth IRA.

Can I take all my money out of my 401(k) when I retire?

You’re free to empty your 401(k) once you reach age 59½ — or 55, in some cases. It is also possible to cash out earlier, although this would incur a 10% early withdrawal penalty.

How long does it take to get a 401(k) distribution?

Times may vary depending on who manages the account. For a more precise timeframe, please contact the HR department of the company you worked for or the financial institution that manages the funds.

What Are My 401(k) Options After Retirement?

In general, retirees with a 401(k) have the following choices: leave your money in the plan until you reach the minimum retirement age (RMDs), convert the account to an individual retirement account (IRA), or start paying out through a benefit in one time, payment in installments or purchasing an annuity through a recommended insurer.

It comes down to

Rules governing what you can do with your 401(k) after retirement are very complicated, shaped by both the IRS and the company that created the plan. Consult your company’s plan administrator for more information. It may also be a good idea to talk to a financial advisor before making any final decisions.

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