How to Make a Withdrawal From a 401(k) Retirement Plan

401(k) Withdrawal

A 401(k) Plan is a retirement plan that lets employees save money for their retirement. Employees can contribute a part of their salary to the 401(k) plan and this contribution is not taxed until withdrawal.

The employer may also make contributions to the employee’s account. This is a great way to save money for retirement.

When you reach retirement age, you will want to start withdrawing money from your 401(k) retirement plan. However, there are rules about how and when you can make these withdrawals.

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Here are some things you should know about withdrawing from your 401(k).

Regular Withdrawals From Your 401(k)

When you reach age 59½, the IRS allows you to take penalty-free withdrawals from your 401(k), even if you are still working. If your plan permits in-service distributions, loans, or hardship withdrawals, you can take them at any time.

However, if your plan does not permit in-service distributions, loans, or hardship withdrawals, you will have to wait until you retire to start withdrawing money from your 401(k).

When you retire, there are rules about how much you can withdraw each year. The IRS requires that you take a required minimum distribution (RMD) from your 401(k) each year, starting at age 73. The amount of the RMD depends on your age and how much money is in your account.

Early Withdrawals From Your 401(k)

If you take a withdrawal from your 401(k) before you reach age 59½, this is considered an early withdrawal.

Early withdrawals are subject to income tax and a penalty of 10% of the amount withdrawn. The IRS does make some exceptions, however.

You can also take early withdrawals without paying the penalty if you are withdrawing money after certain life events: death, divorce, or disability. You may have to pay taxes on these withdrawals, but not the 10% penalty.

Required Minimum Distributions (RMDs) From Your 401(k)

After you reach age 73, the IRS requires that you take a distribution from your 401(k) called an “RMD” each year. You must start withdrawing money from your account by April of the calendar year after you turn 73.

The amount of the RMD depends on how much money you have in your 401(k) account.

For example, if you are 73 years old and have $150,000 in your plan, the IRS requires that you withdraw approximately $500/month. If you do not take enough out each year, you could face a penalty from the IRS.

401(k) Loans

You can also take a loan from your 401(k). This is a great way to get some extra cash in a hurry.

You can borrow up to 50% of the vested account balance, up to $50,000. The interest rate on the loan is usually about one percentage point above the prime rate.

The interest on the loan goes back into your 401(k) account. You pay taxes on the amount you borrow, but if you repay it within five years (or longer depending on your plan), then no penalties are applied.

However, if you do not repay the loan by the tax deadline, this is considered an early withdrawal and you will have to pay both taxes and the penalty.

What Happens to My 401(k) If I Am Fired?

If you leave your job for any reason, including being fired or laid off, you have several options. You can roll over the money into an IRA at another financial firm (often done by those who want more investment choices).

You can also keep it in your current plan if allowed by your former employer. The downside to this is that you will most likely have fewer investment choices and higher fees if your plan is not one of the larger plans with lower costs.

Finally, you can cash out your 401(k) (called a lump-sum distribution) and pay taxes on it at withdrawal, or roll it over into an IRA within 60 days.

If you choose to cash out, the IRS will withhold 20% for taxes. You may also have to pay a penalty if you are under 59½ years old.

What Happens to My 401(k) If I Die?

If you die before withdrawing all of the money from your 401(k), the plan pays out to your named beneficiary.

The amount that goes to them is based on their life expectancy, so younger beneficiaries have lower RMDs than older ones.

If the beneficiary is more than ten years younger than you were when you died (or five years or less), they can take out a lump-sum payment instead of withdrawing the money over time.

If you do not have a beneficiary listed, the plan will pay out to your estate or heirs as determined by state law.

These distributions are based on their life expectancy and may be subject to income tax depending on how much was paid into the plan.

The Bottom Line

You can withdraw money from your 401(k) plan when you retire, but there are rules about withdrawing this money early.

You must pay taxes and penalties on the amount withdrawn, so it is best to leave your retirement account alone until you retire unless you need the money for emergency cases.

If you do need the money, withdrawing from your 401(k) is a better option than withdrawing from a traditional IRA. The rules are similar, but withdrawing early from an IRA could cost as much as 25% more in taxes and penalties.

Take some time to learn all of the withdrawal rules before you plan on withdrawing any money. It is important to know what will happen when you start withdrawing money so that you can plan for the future.

FAQs

1. What happens to my 401(k) if I am fired?

If you leave your job for any reason, including being fired or laid off, you have several options. You can roll over the money into an IRA at another financial firm, keep it in your current plan if allowed by your former employer, or you can cash out your 401(k) (called a lump-sum distribution) and pay taxes on it at withdrawal, or roll it over into an IRA within 60 days.

2. What happens to my 401(k) if I die?

If you die before withdrawing all of the money from your 401(k), the plan pays out to your named beneficiary based on their life expectancy. If there is no beneficiary listed, the plan will pay out to your estate or heirs as determined by state law.

3. When am I eligible for a 401(k) withdrawal?

You can generally start withdrawing money from your 401(k) plan without penalty at age 59½. However, you will have to pay income taxes on the amount withdrawn. If you withdraw money before that age, you may also have to pay a penalty. 

There are some exceptions to this rule, including withdrawing money for a first-time home purchase, medical expenses that exceed 7.5% of your adjusted gross income in any year, disability, and/or death.

4. Can I withdraw my money if my employer terminates my 401(k) plan?

If your employer terminates your 401(k) plan, you may be able to take out the money in the plan. However, you will most likely have to pay income taxes and a penalty on the amount withdrawn. You also will not be able to contribute any more money to the account.

5. How are 401(k) withdrawals taxed?

The amount you withdraw from your 401(k) is taxed as income. So, if you withdraw $20,000 from your account in a year, you will have to pay taxes on that amount as if it was part of your annual income.

This means that withdrawing money from your 401(k) can push you into a higher tax bracket, which may cause you to owe more in taxes than you would have if you had not withdrawn the money at all.