An Overview of 401k Withdrawal Rules

Because the primary purpose of a 401k is to save for your retirement years, the money that goes into that account needs to stay put until you reach retirement age. If you perform any retirement account withdrawals prior to the retirement age set by the federal government, you will have to pay penalties for taking the money too soon.

There are also 401k withdrawal rules regarding tax payments, since money taken out in 401k distributions must be taxed at the time of withdrawal.

This article will cover basic 401k withdrawal rules to help you make savvy financial decisions about your retirement investments.

When Can You Make Retirement Account Withdrawals?

There are three times when 401k withdrawal rules allow for distribution from your 401k plan without an early withdrawal penalty, including:

• When the account holder terminates employment, dies or becomes disabled
• The plan ends and no subsequent plan is offered by the employer
• The account holder reaches legal retirement age (59 ½) or experiences financial hardship.

Even in these circumstances, federal income tax is required on the 401k distribution amount. However, the 10 percent early withdrawal penalty is not applied, according to 401k withdrawal rules, for these specific situations.

Most financial experts do not advise 401k plan participants to make early retirement withdrawals except under the most dire of circumstances. In addition to tax and early withdrawal penalties, earning potential is lost for as many years, as the money could have stayed safely in the tax-deferred 401k plan.

When Must You Make Retirement Account Withdrawals

The 401k plan offers tax deferred contributions, but it does not allow you to escape Uncle Sam forever. At a particular point, you are required to begin 401k distributions in amounts set by a formula established by the IRS. All 401k participants must begin making regular 401k distribution on April 1 of the first year following:

• The year that the participant turns 70 ½
• The year that the participant officially retires

If an individual reaches the age of 70 ½, he must begin making 401k distributions the following year, even if he has not yet retired from the workforce. The formula used to calculate minimum 401k distributions considers the life expectancy of the individual, the age when distributions will begin, and the age of your primary beneficiary, in some cases.

Plan participants who do not begin receiving 401k distributions in accordance with 401k withdrawal rules will be assessed a penalty of up to 50 percent of what should have been withdrawn and what was actually taken out.

When you invest in a 401k plan through your employer, it is important to understand the 401k withdrawal rules long before you are ever ready to touch that nest egg. Because these funds are primarily designed to carry you through the retirement years, the federal government has strict 401k withdrawal rules regarding when and how the money can be taken. When you understand the rules for retirement account withdrawals, you are in a better position to plan for your financial future.
Tim Ord
Ord Oracle

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