The rules for retirement plans, such as a 401k, are designed to help you keep your savings in the plan until you retire. Many of the 401k withdrawal rules apply to all plans, but the business owner or employer sponsoring the 401k has some flexibility in deciding when and how the money will be paid out.
The withdrawal rules will be listed in each employer’s plan document and in the summary plan description employees receive when they enroll in their 401k plan.
If you’re saving in a 401k, you generally cannot take your money out of the 401k, unless you’ve:
You may only withdraw amounts from a 401k that you are vested in. “Vesting” means ownership.
You are always 100% vested in the salary deferral contributions you make to your plan. Employer contributions (e.g., matching or profit sharing contributions) may be subject to a vesting schedule that requires the employee to work for the employer for up to six years to become fully vested in the employer contributions made to the employee’s account. If an employee leaves the employer before becoming 100% vested, the unvested portion of employer contributions in their account will be forfeited back to the plan.
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After you have a distribution event, you can take all of your 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 into an annuity, which is designed to pay out your account balance in a steady stream of payments over your lifetime.
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If your 401k withdrawal is eligible to be rolled over to an IRA or other retirement plan but you choose to take it in cash, 20% of the taxable amount of the withdrawal will be withheld and sent to the IRS as a pre-payment of the income tax owed on the withdrawal. This means that you will receive 20% less than the full distribution amount.
Some types of withdrawals, such as those you are required to take (e.g., when you reach age 70½) are not eligible to be rolled over. If a withdrawal is not eligible to be rolled over, it is subject to a lesser rate of withholding and you may elect to waive that withholding.
To further discourage use of retirement savings before retirement, the tax laws impose an additional 10% tax on withdrawals made prior to age 59½. The 10% tax applies to the taxable portion of a withdrawal. The early withdrawal tax, sometimes called a penalty, is waived for certain reasons. Some of the reasons the 10% early withdrawal tax will be waived include:
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Your 401k plan may allow you to access your savings while you are still working. The two most common ways to do this are through a hardship withdrawal or a loan.
A hardship withdrawal may be taken when the employee or business owner has an urgent financial need. Most plans allow withdrawals for the following types of financial hardships:
Most plans require the employee to stop contributing to the plan for six months following a hardship distribution. Hardship distributions are taxable and subject to the 10% early withdrawal penalty unless an exception applies.
Most 401k plans allow the business owner and employees to take loans from their 401k balances. 401k loans are generally paid back to the plan account, with interest, through payroll deductions.
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The 401k withdrawal rules require you to begin depleting your 401k savings when you reach age 70½.
At this point, you must take a “required minimum distribution” each year until your account is depleted. If you are still working for the employer beyond age 70½, you may be able to delay required minimum distribution until you stop working if your plan allows this delay. The delay option is not available to you if you own 5% or more of the business.
You have until April 1 of the year after you turn 70½ to take your first required minimum distribution. After that, you must take a minimum amount by December 31 each year. Your 401k plan administrator will tell you how much you are required to take each year.
The amount is based on your life expectancy and your account balance. If you don’t take your required minimum distribution each year, you will have to pay a tax of 50% of the amount that should have been taken but was not. If you participate in more than one employer plan, you must take a required minimum distribution from each plan.
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