401k Rules – What You Need to Know About Withdrawal, Distribution, and Rollover

Your 401k is one of the most powerful tools in your investing and retirement toolbox. Do you want to live well after you've left the world of the gainfully employed, but before you've left this world altogether? Make sure you max out your 401k. If you made some good employment choices along the way, your employer kicked in some matching funds and you took full advantage of their generosity.
Now it's time for you to begin living, and you need to fund your retirement so you can tool around Arizona and Nevada in the Prevost. Maybe you're still working and you've changed jobs, hopefully to a new employer that has a handsome 401k plan with contribution matching. Either of these two occurrences may cause you to have some questions about 401k rules for withdrawal, distribution or rollover. Hopefully this post can help.
401k Rules for Withdrawal and Distribution-Want to take some money out of your 401k? Here's what you can and can't do if you'd like to withdraw some funds. The first thing you'll want to look at is your age. There are strict rules regarding age for 401k withdrawals. The magic ages are 59-1/2. and 70-1/2. If you're past 59-1/2 years old you can withdraw funds from your 401k without incurring a penalty from the IRS. The IRS will withhold 20% of the total amount you withdraw, however. This will count toward your income tax due for the year. If you're lucky, an planned well, you may have a refund coming. In that case, the 20% will be basically a short term, interest free loan to the U.S. Government, and you'll get some or all of it back in the form of a refund.
The 59-1/2 and 70-1/2 ages refer to April of the calender year in which the plan participant reaches them. You must take your distribution to qualify. If you don't take a distribution in the starting year, the required distributions for 2 years must be made in the next year (one by April 1 and one by December 31).
If you are under age 59-1/2, you can still withdraw money from your 401k plan, but the IRS will ding you 10% for the privilege. The rules here state that there are actually limited circumstances where you can avoid the 10% early withdrawal penalty. These circumstances include total and permanent disability, death (also total and permanent for most of us), medical expenses that exceed 7.5% of your adjusted gross income for the year, ESOP dividends for your employer's securities (in the 401k), and the IRS levy of your plan.
If you're over 70-1/2 years old, you are required to begin taking mandatory withdrawals. You can leave the money in the plan if you have more than $5,000 (otherwise they'll usually just cut you a check), but that's cost prohibitive, as your friends at the IRS will take a full 50% of your minimum distribution. That basically means you have to begin taking that minimum distribution.
401k Rules for Rollover –If you leave the employer who sponsors a particular 401k that you have funds invested in, you may want to move your money into one of 2 other investment vehicles; another 401k (if the plan allows such transfers), or an IRA. Your funds in a 401k aren’t actually owned by you, they’re in a trust owned by your employer. An IRA, on the other hand, is really your asset. This is the reason it’s more complicated to move assets from a 401k plan than it is to transfer them from an IRA.
If you’re moving to a different employer, you may want to transfer your assets from your old employer’s 401k plan to your new employer’s plan. On the other hand, it may fit your financial plan better if you move it to an IRA. The process of transferring assets from your 401k into another one, or into an IRA, is termed “rollover”. Rollover is the financial term for moving assets from one tax protected entity into another.
In order for you to rollover a 401k, you’ll first have to set up an account for the funds to go to, if you don’t have one already. This is not created at the time of the rollover, but before. The primary rules that apply to a 401k rollover are as follows;
Rule 1 - If the money is transferred directly to you, you have a 60 day window to make sure it gets to the other tax deferred account. If you miss the 60 day window, you’ll owe a 10% penalty if you’re under age 59-1/2.
Rule 2 - You can roll it over without the 20% IRS withholding if the dollar amount is greater than $5,000. If it’s smaller than that, you’ll normally just get the distribution check sent to you, less the 20% IRS withholding.
Rule 3 – There are some changes coming for tax year 2008. After 2007, you will be able to roll over your 401k directly to a Roth IRA if you make less than $100,000, and are not married filing separately.
Rule 4 – Although the rollover is not viewed as a taxable event by the IRS, you still must report it on your federal income tax return, so don’t forget to do so.
Rule 5 – There are certain distributions that do not qualify for rollover status. These include required minimum distributions for those older than 70-1/2, hardship distributions, employer stock dividends, life expectancy based payments over a greater than 10 year period, and life insurance payments.
For more information on rules for 401k rollovers, see the IRS, here.
Have a great, Debt Free, weekend.