If you participate in a 401(k) plan, you should understand the rules for withdrawing money from your account – otherwise known as taking a distribution – even if you don’t plan to touch this money for decades. 401(k) plans have restrictive distribution rules that are tied to your age and employment status. If you don’t understand your plan’s rules, or misinterpret them, you can pay unnecessary taxes or miss distribution opportunities.
We get a lot of questions about distributions from 401(k) participants. Below is a FAQ with answers to the most common questions we receive. If you are a 401(k) participant, you can use our FAQ to understand when you can take a distribution from your account and how to avoid penalties.
When am I eligible for a 401(k) distribution?
In general, you can’t take a distribution from your 401(k) account until one of the following events occurs:
- You die, become disabled, or otherwise terminate employment
- Your employer terminates your 401(k) plan
However, a 401(k) plan can also permit distributions while you are still employed. These “in-service” distributions are subject to the following conditions:
- 401(k) deferrals (including Roth), safe harbor contributions, QNECs and QMACs can’t be distributed until age 59.5
- Non-safe harbor employer match and profit sharing contributions can be distributed at any age.
- Employee rollover and voluntary contributions can be distributed at any time.
- 401(k) deferrals (but not their earnings), non-safe harbor contributions, rollovers and voluntary contributions can be withdrawn in a “hardship distribution” at any time.
To find the in-service distribution rules applicable to our 401(k) plan, check your plan’s Summary Plan Description (SPD).
What’s a hardship distribution?
A 401(k) plan may, but is not required to, allow hardship distributions from your account if you experience an “immediate and heavy” financial need. These distributions can’t exceed the amount “necessary to satisfy” your need (plus any taxes or penalties that may result from the distribution).
- The IRS deems the following expenses to be “immediate and heavy”:
- Expenses for medical care previously incurred by you, your spouse, or any dependents or necessary for these persons to obtain medical care
- Costs directly related to the purchase of your principal residence (excluding mortgage payments)
- Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for you, or your spouse, children, or dependents
- Payments necessary to prevent eviction from your principal residence or foreclosure on the mortgage on that residence
- Funeral expenses
- Certain expenses to repair damage to your principal residence
- The IRS deems a hardship distribution “necessary to satisfy” an immediate and heavy financial need when:
- You have obtained all other currently available distributions and loans under 401(k) plan (unless a loan would increase your need); and
- You are prohibited from making 401(k) deferrals for at least 6 months after receipt of the hardship distribution.
Additional information about hardship distributions can be found on the IRS website.
When can I rollover a 401(k) distribution?
You can avoid taxes on a 401(k) distribution by rolling your account to a personal IRA or new employer’s 401(k) plan. However, not all distributions are considered “rollover-eligible,” including:
- Hardship distributions
- Required Minimum Distributions
- Distributions to correct plan testing failures
“Direct” rollovers are the most common type of rollover. When you request a direct rollover of your account, you receive a check made out to the new IRA or 401(k) plan. You can also rollover a distribution paid directly to you within 60 days. These “indirect” rollovers are rare because rollover-eligible distributions paid directly to you are subject to mandatory 20% Federal income tax withholding. That means you’ll need to use personal funds to roll over your full distribution.
Additional information about 401(k) rollovers can be found on the IRS website.
Can I leave my money in my 401(k) plan after I terminate employment?
It depends upon your account balance and the terms of your 401(k) plan. The IRS allows 401(k) plans to automatically “cash-out” small account balances – defined as less than $5,000 – without the owner’s consent upon their termination of employment. Under these rules, account balances between $1,000 and $5,000 must be rolled over into a personal IRA for the benefit of the employee. Amounts below $1,000 can be paid out by check.
To find the cash-out limit applicable to your 401(k) plan, check your plan’s Summary Plan Description (SPD). If your account exceeds this limit, you can postpone distributions until the date you must start taking Required Minimum Distributions.
When must I start taking Required Minimum Distributions from my 401(k) account?
You can’t postpone distributions from your 401(k) account indefinitely. Under the IRS’ Required Minimum Distribution (RMD) rules, you must commence annual distributions from your 401(k) account no later than your Required Beginning Date (RBD). If you own 5% or less of your employer, your RBD is the April 1 following the end of the calendar year in which the later of two events occurs:
- you attain age 72 or
- you retire.
If you own more than 5%, you RBD is April 1 following the close of the calendar year in which you attain age 72, regardless of whether you retire. December 31 is the annual deadline for subsequent RMDs.
Your annual RMD amount is determined by applying a life expectancy factor set by the IRS to your account balance at the end of the previous year. You can estimate your RMDs in retirement by using an online calculator.
How are 401(k) distributions taxed?
If a rollover-eligible distribution is made to you in cash, the taxable amount will be reduced by 20% Federal income tax withholding. Non-rollover eligible distributions (e.g., hardships, RMDs) are subject to 10% withholding unless you elect a lower amount. State tax withholding may also apply depending upon your state of residence.
However, your ultimate tax liability on a 401(k) distribution will be based on your Federal income and state tax rates. That means you will receive a tax refund if your actual tax rate is lower than the withholding rate or owe more taxes if it’s higher.
If a 401(k) distribution is made to you before you reach age 59½, the taxable amount will be subject to a 10% premature distribution penalty unless an exception applies. This penalty is meant to discourage you from withdrawing your 401(k) savings before you need it for retirement. You can avoid the 10% penalty under the following circumstances:
- You terminate service with your employer during or after the calendar year in which you reach age 55
- You are the beneficiary of the death distribution
- You have a qualifying disability
- You are the beneficiary of a Qualified Domestic Relations Order (QDRO)
- Your distribution is due to a plan testing failure
A full list of the exceptions to the 10% premature distribution penalty can be found on the IRS website.
How are distributions of Roth 401(k) deferrals taxed?
Because Roth 401(k) deferrals are contributed to your account on an after-tax basis, they are never taxable upon distribution. Their earnings can also be distributed tax-free when they’re part of a “qualified distribution.” A qualified distribution is one that occurs 1) at least five years after the year you made your first Roth deferral and 2) after the date you:
- Attain age 59½,
- Become disabled, or
If you withdraw Roth 401(k) deferrals as part of a non-qualified distribution, their earnings are taxable at applicable Federal and state rates and may be subject to the 10% premature distribution penalty.
Additional answers to Roth questions can be found in our Roth FAQ.
Know your options!
401(k) distribution rules are complex and restrictive. They are designed to disincentivize you from withdrawing your retirement savings prematurely. Before you take a distribution from your 401(k) account, you should discuss your options with your CPA. They can help you plan a distribution and minimize your taxes.