Understanding 401k Withdrawal Rules

For years you diligently contributed to your 401K retirement plan. But now, you’re coming closer to the time when you need to consider your 401K’s withdrawal rules. There are also changes to the 401K hardship withdrawal rules you should know about.

What’s the Difference Between Withdrawal and Distribution?

These two terms are interchangeable, though at times, can still be confusing to most 401K plan holders. The IRS prefers to use the term “distributions” in its 401K guides and literature. The word “withdrawal” tends to be associated with the term 401K hardship withdrawal. The logic is that 401K plans organically begin to distribute money at certain ages versus the more negative connotation of forcing the withdrawal of money from your plan too early, which leads to penalties.

Age Withdrawal Rules

You can’t keep funds in your 401K for eternity. The IRS requires you to start withdrawing or taking distributions when you reach the age of 70 and 1/2 years of age. Here are a few other age withdrawal rules:

  • You can take your first distribution any time in the calendar year in which you turn 70 and 1/2, according to Kiplinger.com.
  • Even if you haven’t formally retired at age 70 and 1/2 you’re still required to make minimum withdrawals, called RMDs.
  • You can begin taking distribution when you turn 59 and 1/2 and you won’t be charged any penalties, according to The Motley Fool.

More About RMDs

RMDs, known as required minimum distributions, need to be taken or you could get hit with a harsh penalty, which is worse than early withdrawal penalties, according to The Motley Fool.

An RMD is based on the total balance of all of your tax-deferred retirement accounts. With that said, the IRS doesn’t care how many accounts you have, but it wants you to divide your RMD between all the accounts, or just from one, but a withdrawal must be made, states Motley Fool.

What About Taxes on Withdrawals?

You’ll pay taxes on distributions from a regular 401K plan. Since contributions were made with pre-tax dollars to reduce your income tax, of course you’ll be taxed when you actually use the money, which is considered earned income.

Contribution rules differ for a Roth 401K plan, so you won’t be taxed down the line when you withdraw the money. If an employer matched contributions, however, you’ll pay taxes on that portion of the distribution.

Hardship Withdrawal Rules

If you are in serious and immediate need of funds to pay for unexpected medical expenses, tuition, housing issues or funeral expenses, you may be eligible to take a hardship withdrawal from your 401K plan. Hardship withdrawals, considered earned income, will be subject to income taxes and a 10 percent penalty if you’re under 59 and 1/2 years of age.

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Some of the rules for hardship withdrawals from a 401K plan have changed in 2019. Consult your plan’s administrator for details. One change, for example, is that a 401K plan’s safe harbor regulations have changed. That regulation used to require a six-month suspension on employee contributions after receipt of a hardship withdrawal, but is now removed, according to Fidelity Investments.

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