Retirement Basics Distribution Options

There are multiple scenarios in which an individual could take distributions from their 401(k) or other qualified retirement plan. Here you will find the explanations and rules for each different type of distribution. It is important to consider all of the factors associated with the taxes and penalties before an individual starts withdrawing money from their 401(k), as these can have a significant effect on how long an individual’s retirement money will last.

Non-penalized withdrawals

An employee is allowed to begin taking non-penalized withdrawals at the age of 59.5, however, the individual is not required to start taking withdrawals until he or she reaches the age of 70.5. If an individual chooses to take distributions before they reach the age of 59.5, they are subject to a 10% distribution penalty on top of income taxes at the individual’s current income tax bracket. Once an individual has reached the age of 59.5, they have several distribution options:

• Non-Periodic Withdrawals: the most common type of non-periodic withdrawals is a cash lump sum in which the plan participant can choose to receive the check for the value of their 401(k) with 20% withheld for federal income taxes and 2-8% withheld in state income taxes. All money withdrawn will count as current income for the taxable period.
• Periodic Withdrawals: individuals can take periodic withdrawals in the form of an annuity or, if they choose, in periodic distributions of random sizes. It is important to note that all withdrawals from 401(k) are taxed as current income, so everyone qualified for withdrawals should consider a strategy that limit the amount of income taxes the plan owner is required to pay.

Hardship Withdrawals

An individual is eligible for withdrawals at the age of 59.5 if the withdrawn funds are used for a financial hardship. All hardship withdrawals are subject to a 10% early withdrawal as well as income taxes. The IRS does not require employers to provide hardship withdrawals, so it is important to check with your plan administrator before withdrawing money. Four criteria must be met to be considered a hardship, according to the IRS:

• The withdrawal is necessary due to an immediate and severe financial need
• The withdrawal is necessary to satisfy that need (i.e., you can’t get the money elsewhere)
• The amount of the loan does exceed the amount of the need
• You have already obtained all distributable or non-taxable loans available from your 401(k) plan

The following reasons are considered acceptable by the IRS for hardship withdrawals:

• Non-reimbursed medical expenses for the plan owner, their spouse, or their dependents
• Purchase of principle residence
• Payment of tuition and other related educational expenses
• Necessary payments to avoid eviction from principle residence
• Funeral expenses
• Expenses relating to repair of principle residence damage

Required Minimum Distributions (RMD)

If an individual reaches the age of 70.5 they are required by the IRS to start taking distributions. The RMD can be taken at any time throughout the year, but must be taken before December 31. All RMDs are taxed as current income, and an individual is subject to a 50% penalty from the IRS if they should fail to take their RMD for the year. The amount of the RMD is calculated by dividing the balance as of December 31 of the prior year by a life expectancy factor, which is determined by the IRS.