401(k) Distribution Rules

When can I take my money out of my 401(k)?

You generally cannot take your money out of a 401(k) unless you have had a “distribution event” such as:

• Reaching age 59½ or older
• Leaving the employer
• Becoming disabled

Each plan will have a list of “distribution events.

Can I take money out of my 401(k) while I am still working?

Your 401(k) plan may allow you to access your savings while you are still working and before you have a “distribution event.” The two most common ways to access your account before retirement are by taking a loan from your 401(k) account, which you will have to pay back, or by taking a distribution because you have a financial hardship.

How do I qualify for a financial hardship distribution?

Most 401(k)s allow distributions for the following types of financial hardships:

• Certain medical expenses
• Purchase of a principal residence
• Tuition and related educational fees
• Preventing eviction or foreclosure on principal residence
• Funeral expenses
• Repair of certain damages to a primary residence

You will be required to provide documentation to prove your hardship and the dollar amount needed. Hardship distributions are taxable if you distribute pre-tax savings. If you are younger than age 59½, you will also owe a 10% early distribution tax unless you meet an exception.

What are the exceptions to the 10% early distribution tax?

The 10% early distribution tax, sometimes called a penalty, is waived if you are:

• Disabled
• Taking a series of equal payments that meet certain requirements under the tax laws
• Ending employment with the employer sponsoring the plan, after reaching age 55
• Divorced and taking a portion of your former spouse’s 401(k) under a court order
• A beneficiary and are taking a distribution from a 401(k) account you inherited
• Removing an excess contribution because you contributed too much in one year to a 401(k)
• Taking money out of your 401(k) to pay unreimbursed medical expenses that exceed 10% of your adjusted gross income

How can I take my money?

If you have a distribution event, you can take your entire vested account balance out of the plan (called a lump sum distribution). Some plans allow partial payouts or installment payments, such as a specific dollar amount each year or each quarter. Some plans allow you to convert your retirement savings to an annuity, which is designed to pay out your account balance in a steady stream of payments over your lifetime.

What does “vesting” mean?

“Vesting” means ownership. You are always 100% vested in the salary deferral contributions you make to a 401(k), but employers may assign a vesting schedule to the contributions they make to the plan (matching or profit-sharing contributions). A vesting schedule requires you to work for the employer for a period of time before owning 100% of the employer contributions made to your account. A vesting schedule can be as long as six years. If you leave the employer before becoming 100% vested, the unvested portion of your account will be forfeited.

How will my 401(k) distribution be taxed?

If you are taking a cash payment and not rolling over any of the distribution, the tax impact will depend on two factors: the types of contributions you or your employer made to your account and your age.

If your 401(k) account holds only contributions that were deducted from your paycheck before income taxes were withheld, contributions made by your employer, and investment earnings, you must include the full amount of distribution in your taxable income in the year you take the distribution.

If you made Roth contributions to your 401(k) plan, you would not be taxed on the amount of the Roth contributions you take out of the plan since you paid taxes before putting the dollars into the plan. The earnings portion of your Roth 401(k) distribution will also be tax-free if the distribution is “qualified.” To take a qualified distribution, you must have had a Roth account for at least five years, and the distribution is taken after you reach age 59½, die, or become disabled. If you take a “nonqualified” distribution, you must include the earnings portion of the distribution in your taxable income in the year you take the distribution.

If you are younger than age 59½ when you take a distribution, and you do not meet one of the early distribution exceptions, you will owe an additional 10% tax on your distribution. Additionally, your 401(k) administrator generally must withhold 20% of your taxable distribution.

Is there income tax withholding on a 401(k) distribution?

If your 401(k) distribution was eligible to be rolled to another 401(k) or an IRA, but you choose to take it in cash instead, 20% of the taxable amount distributed must be withheld and sent to the IRS as a pre-payment of the income tax you owe on the distribution. This means that you will receive 20% less than the full distribution amount.

Some types of distributions are not eligible to be rolled over, such as distributions you are required to take beginning at age 72. If a distribution is not eligible to be rolled over, it is subject to a lesser rate of withholding, and you may elect to waive that withholding.

Am I ever required to take a distribution from my 401(k)?

There are two situations in which you can be forced to take money out of a 401(k):

• If you leave your employer and your vested account balance is less than $5,000 – The employer can cash you out of the plan without your consent if you do not make a distribution election. If your balance is over $1,000, but less than $5,000, your account will be rolled over to an IRA.
• When you turn age 72– The 401(k) distribution rules require you to begin depleting your 401(k) savings when you reach age 72. At this point, you must take a “required minimum distribution” each year until your account is depleted. Your 401(k) administrator will tell you how much you are required to take each year.