401(k) Distributions

It may please you to learn that someday you will actually get to use the money you have accumulated in your 401(k) plan. Retirement plans like 401(k)s would be very unpopular if that weren't the case.

Generally, distributions from a 401(k) plan may occur for the following reasons:

• retirement, death, disability, or other separation from service
• termination of the plan without establishing a replacement plan
• sale of substantially all of a business's assets
• sale of a subsidiary
• authorized hardship distribution

If you want to keep your money in a 401(k) plan indefinitely, forget it. The government won't wait forever to get its share. As a result, the tax code requires minimum distributions from the plan to begin by the calendar year when the account holder retires or attains the age of 70-1/2, whichever is later.

Financial Calculators The IRS requires that you withdraw at least a minimum amount, known as a required minimum distribution, from your retirement accounts annually, starting the year you turn age 70-1/2. Use this Required Minimum Distribution Calculator to calculate the amount that must be distributed. IRS rules allow for penalty-free withdrawals from retirement accounts. You may begin receiving money from your retirement accounts before you reach age 59-1/2, without the normal 10 percent penalty. Use this 72(t) calculator to determine your allowable 72(t)distribution and how this strategy can help fund your early retirement.

Benefits under a 401(k) plan are taxed only when actually distributed to the account holder or the account holder's beneficiary. Benefits are not taxed if they are merely made available or constructively received. So, to the extent you can do so, deferring the receipt of benefits will result in the deferral of the tax on the benefits.

Financial Calculators When you are the beneficiary of a retirement plan, specific IRS rules regulate the minimum withdrawals you must take. If you want to simply take your inherited money right now and pay taxes, you can. But if you want to defer taxes as long as possible, there are certain distribution requirements with which you must comply. Use this Beneficiary Required Minimum Distribution Calculator to determine your Required Minimum Distributions (RMD) as a beneficiary of a retirement account.

Hardship distributions. A 401(k) plan may authorize hardship distributions of elective deferrals to plan participants who are experiencing immediate and heavy financial need, provided other resources are not reasonably available to meet that need. If a hardship distribution is made, however, an employee cannot make any elective or after-tax contributions to the 401(k) or any other plans maintained by the employer for at least six months after the receipt of the hardship distribution. The theory behind this restriction is that somebody who has an immediate and heavy financial hardship should not, at the same time, be able to defer salary to a retirement plan.

Example Joe Bob receives a hardship withdrawal from his employer's 401(k) plan on March 1, 2013, after a tornado destroys his mobile home. Joe Bob cannot make any new contributions to a retirement plan until September 1, 2013.

A hardship distribution cannot also qualify as an eligible rollover distribution. This means that you can't receive a hardship distribution and then try to roll it over to an IRA.

Plan loans. Some 401(k) and other retirement plans may allow you to borrow money from you retirement plan account. If a loan program is available, you may borrow the lesser of $50,000 (reduced by any previous outstanding loans) or half of the present value of your nonforfeitable accrued benefit.

Plan loans must generally be repaid with interest within five years of the date of the loan, even if an employee terminates employment. However, the five-year repayment rule does not apply to any loan used within a reasonable period of time to acquire a principal residence. Plan loans that are not repaid with interest as required are considered distributions and subject to any associated income taxes and the 10 percent early distribution penalty.

Some plan loans may be penalized by a hefty excise tax (15 percent initially, then 100 percent if not corrected) because of the prohibited transaction rules for qualified retirement plans. These rules are there to prevent those who can control a plan from abusing their position. The average employee, however, is not affected by the prohibited transaction rules.

© 2024 Wolters Kluwer. All Rights Reserved.