Retirement Plan Withdrawals
Participant Withdrawals & Tips
Withdrawals are payouts of assets from a 401(k) or 403(b) plan with no intention of your returning the assets to the plan. Withdrawals include in-service withdrawals, payments made upon termination or retirement, and may also include certain distributions related to qualified domestic relations orders. Loans taken from a qualified plan are not distributions unless the loan is not repaid and the transaction is deemed a distribution.
When can I take a 401(k) or 403(b) withdrawal?
The IRS says that you can withdraw your funds if one or more of the following conditions are satisfied:
- You terminate employment be it voluntarily or involuntarily
- You die or become disabled, or
- Your employer dissolves the 401(k) or 403(b) plan.
Additionally, your employer’s plan may, but not required to, allow you to make withdrawals while you are actively employed, or better known as “in-service” withdrawals:
- Hardship withdrawal. These distributions can only be provided if there is an immediate and heavy financial need and the withdrawal is necessary to satisfy such need. Whether an employee has an immediate and heavy financial need is to be determined based on all the relevant facts and circumstances. Generally, for example, the need to pay funeral expenses of a family member would constitute an immediate and heavy financial need. A distribution made to an employee for the purchase of a boat or television would generally not constitute a distribution made on account of an immediate and heavy financial need.
- Age 59-1/2 withdrawal. You can typically take a full distribution from all money types after reaching age 59-1/2. Your plan may require you to be 100% vested, or have other conditions.
- Rollover contributions. You may be able to withdrawal your rollover contributions that you previously brought over from your former employer’s plan or IRA.
For more details about in-service withdrawals specific to your plan, review your plan’s Summary Plan Description (SPD).
What are my options if I terminate employment or retire with my employer and have an account?
When you leave a job, you have four basic options for handling your 401(k) or 403(b).
1. Do nothing/keep the account with your former employer. If your vested account balance is greater than $5,000, you may elect to leave it in the Plan. You may be charged a maintenance fee. Be sure to update your address if necessary. However, if your vested account balanced is less than $5,000, your old employer may remove you from their Plan and either send you a check or set up an IRA under your name.
2. Rollover your account to an IRA. Most popular choice among all options, you may elect to roll your funds over to an Individual Retirement Plan (IRA). You can then reinvest the funds and continue to contribute into the account periodically. You will still receive a Form 1099-R for IRS reporting purposes but won’t be taxed.
3. Rollover your account to your new employer’s Plan. You can take the funds from your old account and transfer it to your new employer. You can then continue to contribute into the new plan. Again, you will still receive a Form 1099-R for IRS reporting purposes but won’t be taxed.
4. Take a cash distribution. Unlike the rollover options mentioned above, this will be a taxable distribution. Generally, a 20% tax is deducted upfront. Also, state tax may be deducted depending on where you reside. Note that taxable distributions taken before attainment of age 59-1/2 are generally subject to penalties, although there are some exceptions.
This is not intended to provide tax advice. You are encouraged to seek the advice of your accountant or tax advisor.
How do I rollover my old account to my current employer's plan?
Check with your current employer. First things first: ask your employer or human resources if the Plan allows rollover, and if yes request the necessary form or paperwork, which will contain vital information you will need to initiate the rollover.
Contact your former employer or their provider. If you have online access to your old account, you can likely initiate the rollover by logging into your account and completing the necessary form online. If not, contact human resources, who will either provide you the necessary paperwork or have you contact their retirement plan provider. You will need to complete the paperwork and send it in. This is where you will indicate that you wish rollover your account into your new employer’s Plan.
Deposit your funds. You may be able to request your funds be deposited into your new account electronically. Absent electronic deposit option, you will receive a check. You then will need to mail in the check to your new employer’s plan provider along with the necessary form. Some retirement plan providers may allow you to download their app and deposit the check electronically by taking a picture.
In summary, ask your current employer for the rollover paperwork, then contact your former employer for instructions on how to initiate the rollover into your new employer’s plan and finally deposit your funds.
How are 401(k) and 403(b) withdrawals taxed?
Distributions from 401(k) and 403(b) plans are generally subject to ordinary income tax because the plan usually contains both contributions and earnings that have never been subjected to income tax. The contributions to the plan were effectively wages that would have been taxed at ordinary income tax rates had they been paid directly to the participant. These contributions have not yet been subjected to income tax because the benefits were held in a qualified plan. Therefore, when the funds are distributed, they are included in your income and are taxed as ordinary income at the value upon distribution.
If you choose a cash distribution, the entire account will be taxable, and the amount will be reduced upfront by 20% federal income tax withholding. Your actual tax liability, however, on your 401(k) or 403(b) distribution will be based on your federal income and state tax rates for the year. In other words, when you file your tax return and report the distribution amount, you will receive a tax refund if your actual tax rate is lower than the withholding rate or owe more taxes if your tax rate is higher.
If you make a withdrawal before you turn age 59-1/2, you will pay a 10% early withdrawal penalty. The purpose of this penalty is to keep your retirement savings for golden years. Are there any exceptions to this 10% penalty? Yes, see IRS site here.
However, if you elect to roll over your account into your current employer’s plan or IRA, your withdrawal will not be taxed.
Must I take Required Minimum Distribution from my 401(k) or 403(b) account?
Yes. Funds in a 401(k) or 403(b) plan enjoy tax-deferred growth. However, this favorable tax treatment is for the purpose of encouraging you to save for retirement. The IRC has established age 72 (which was changed from 70-1/2 as of 1/1/2020) as the maximum deferral age before distributions must begin. Once you attain the age of 72, you must start taking required minimum distribution (RMD). If the funds are not distributed by the required date, a 50 percent excise tax will be levied on you for failure to take the RMD.
The first RMD must be taken by April 1 of the year following the year you attain the age of 72. However, for each year thereafter, the RMD must be taken before December 31 of the tax year. The special first year option allows you to delay the first payment until April 1 following the year in which the participant turns 72. However, such a delay only applies to the first distribution and could cause a bunching of income in the year after the participant attains the age of 72. If you delay taking the first RMD until April 1 of the year following the attainment of age 72, the second RMD must still be taken by December 31 of that same year.
An exception to the general RMD for qualified plans exists if you’re still employed upon attainment of age 72. If you’re actively employed by your employers, you do not need to take RMD until April 1 of the year after you retire or terminate employment. The exception is not available if you’re more than five (5) percent owner in the year you reach age 72.