An estimated 79% of Americans have access to a 401(k) plan as part of their employee benefits package and are able to save and invest in a tax efficient way for retirement. If you’re one of the 79%, let’s fast forward a few years to when you’re ready to retire because you’ll want to know to how to withdraw your money when it’s time. That’s the whole point – you’re saving and investing to support yourself (and your family) in retirement.
Withdrawing money from a 401(k) is commonly referred to as “taking a distribution” and it can involve some complicated rules based on age and employment status. Taking a distribution also means you’ll be paying taxes, and possibly penalties, so pay close attention when you decide to withdraw your money. To avoid the penalties and keep as much of your money as you can, remember these three numbers:
59.5: This is the age that you can begin withdrawing your funds from the plan without a 10% penalty. If you leave a job before age 59.5, you should try to leave your 401(k) where it is (it still belongs to you, don’t worry), roll it over to a new 401(k), or roll it into an Individual Retirement Account (IRA). If you take it as cash instead, that’s a distribution to you and you’ll have to pay taxes and a 10% penalty on it.
55: An exception to the 59.5 rule is if you’re at least 55 years old (or age 50 for public safety employees) at the time you leave a job, you’re allowed to take a distribution from that company’s plan without a penalty.
72: This is the age that the IRS requires you to start withdrawing your money. You’ve postponed paying taxes on those pre-tax contributions for several years and now the IRS wants their share. You have to begin taking RMDs (Required Minimum Distributions) by April 1 of the year after you turn 72 to avoid a penalty and you can’t roll them over to another plan or IRA. The amount you have to withdraw each year is based on your account balance and life expectancy. An exception to this rule is if you’re still working at age 72 (and you don’t own 5% of the company), you can postpone the RMD for this company’s plan until you do leave.
Note: As of 1/1/20, the age required to start RMD was changed from 70.5 to 72.
Here’s the short version: don’t take money out of your 401(k) plan until you’re 59.5, and once you hit 72 make sure you’re taking the RMD’s. If you absolutely need the money now, look into 401(k) loans, hardship withdrawals and in-service distributions, depending on your employer’s offering. If you leave a job before 59.5 either leave the 401(k) where it is, roll it over into your new employer’s plan, or into an IRA to avoid cashing it out and withdrawal penalties.
401(k) distributions can be complicated and the rules are designed to keep participants from withdrawing their retirement money early. So be sure to check with your plan administrator and discuss with an adviser before taking a distribution.