Your 401(k) Distribution Guide

You likely already know a 401(k) plan is a company-sponsored retirement account that employees can contribute to. And you probably know you can’t keep retirement funds in your 401(k) forever.

But do you know the rules on taking distributions from that account? Here you’ll find answers to some of the most frequently asked questions on 401(k) distributions.

When do my distributions begin?

Typically, distributions won’t begin from your 401(k) account until one of the following occurs:

  • You die, become disabled, or otherwise have a severance from employment.
  • The plan terminates and no successor defined contribution plan is established or maintained by the employer.
  • You reach age 59½ or experience a financial hardship.

The required beginning date is April 1 of the first year of the following years, whichever is later:

  • The calendar year in which you reach age 72 (70 ½ if you reach age 70 ½ before Jan. 1, 2020).
  • The calendar year in which you retire.
  • A plan may require you to begin receiving distributions by April 1 of the year after you reach age 72 (70 ½ if you reach age 70 ½ before January 1, 2020), even if you have not retired.

Who oversees my distributions?

If your account balance is to be distributed, the plan administrator must determine the minimum amount required to be distributed to you each calendar year.

Depending on the terms of the plan, distributions may be:

  • Nonperiodic, such as lump-sum distributions or
  • Periodic, such as annuity or installment payments.

In certain circumstances, the plan administrator must obtain your consent before making a distribution. Generally, if your account balance exceeds $5,000, the plan administrator must obtain your consent before making a distribution. Depending on the type of benefit distribution provided under your 401(k) plan, the plan may also require the consent of your spouse before making a distribution. Your plan may provide that rollovers from other plans are not included in determining whether your account balance exceeds the $5,000 amount.

If a distribution over $1,000 is made, and you (or your designated beneficiary) do not elect to receive the distribution directly or roll over the amount to an eligible retirement plan, the plan administrator is required to transfer the distribution to an individual retirement plan of a designated trustee or issuer. The plan administrator must notify you (or your beneficiary) in writing that the distribution may be transferred to another individual retirement plan.

Distributions from your 401(k) plan are taxable unless the amounts are rolled over as described below. If you receive a lump-sum distribution from a 401(k) plan and you were born before 1936, you may be able to elect optional methods of figuring the tax on the distribution.

What’s a hardship distribution?

A hardship distribution is a withdrawal from a participant’s elective deferral account made because of an immediate and heavy financial need and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower’s account.

Is my new boat/flat screen TV/European vacation an immediate and heavy financial need?

Probably not (sorry). But certain expenses you incur voluntarily can count, and the IRS allows eligible expenses including, but not limited to:

  • Expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care;
  • Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
  • Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for the employee, or the employee’s spouse, children, or dependents;
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;
  • Funeral expenses; or
  • Certain expenses relating to the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under IRC § 165.

What if I want to roll funds over to my 401(k) from another retirement plan?

You can rollover (receive a distribution from one qualified retirement plan and contribute all or part of it to another qualified plan or traditional IRA) most distributions except:

  • A distribution that is one of a series of payments based on life expectancy or paid over a period of ten years or more,
  • A required minimum distribution,
  • A corrective distribution,
  • A hardship distribution, or
  • Dividends on employer securities.

A rollover transaction is not taxable, but it is reportable on your tax return. Any taxable amount not rolled over must be included in income in the year you receive it.

Keep in mind:

  • If the distribution is paid to you, you have 60 days from the date you receive it to roll it over.
  • Any taxable distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll the distribution over later.
  • If the distribution is rolled over, and you want to defer tax on the entire taxable portion, you will have to add funds from other sources equal to the amount withheld.
  • You can choose to have your 401(k) plan transfer a distribution directly to another eligible plan or to an IRA (under this option, no taxes are withheld)

If you are under age 59 ½ at the time of the distribution, any taxable portion not rolled over may be subject to a 10% additional tax on early distributions (see next question).

I’ve heard I could get taxed for early withdrawals from my 401(k) account. Is that true?

If you take a distribution under your plan before you reach age 59½, you may have to pay a 10% additional tax on it. This tax applies to the amount received that you must include in your income.

Exceptions

The 10% tax will not apply to distributions before age 59 ½ if they are:

  • Made to a beneficiary (or to the estate of the participant) on or after the death of the participant
  • Made because the participant has a qualifying disability
  • Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the participant or the joint lives or life expectancies of the participant and his or her designated beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59½, whichever is the longer period.)
  • Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55
  • Made to an alternate payee under a qualified domestic relations order (QDRO)
  • Made to a participant for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the participant itemizes deductions)
  • Timely made to reduce excess contributions
  • Timely made to reduce excess employee or matching employer contributions
  • Timely made to reduce excess elective deferrals
  • Made because of an IRS levy on the plan
  • Made because of certain disasters for which IRS relief has been granted

Can I borrow money from my 401(k)?

Some 401(k)s permit you to take out a loan from your plan.  Your plan document will specify if loans are allowed. These loans, if permitted, are not taxable if they meet the criteria below:

  • Generally, you may borrow up to 50% of your vested account balance (up to a maximum of $50,000).
  • The loan must be repaid within five years unless it is used to buy your main home.
  • The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan.
  • You must reduce the $50,000 amount, above, if you already had an outstanding loan from the plan (or any other plan of your employer or related employer) during the 1-year period ending the day before the loan.
  • The reduction amount is your highest outstanding loan balance during that period minus the outstanding balance on the date of the new loan.

Note: Consider other loan sources before you borrow from your 401(k) plan, as loans may negatively affect your account earnings and reduce the money you will eventually have available for retirement.

Source: IRS 401(k) Resource Guide, https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules

Published 11.04.2021


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