What are the Different 401k Withdrawal Rules?

There are numerous 401k withdrawal rules that regulate deductions from these types of retirement accounts. For example, there are hardship rules that allow people to make early deductions for certain reasons. There are regulations that outline penalties for other early distributions, such as one that may occur when a person changes employers. Once an individual reaches 70 and a half years, she is still subject to 401k withdrawal rules, such as the one that requires a certain total annual deduction.

These types of accounts are designed to hold money until retirement, which for this purpose, is considered 70 and a half years of age. These 401k accounts are subject to what is known as hardship rules, however, which allow individuals to withdraw money for certain pressing needs. Hardship deductions differ from 401k loans in that the money does not need to be paid back.

Instances when individuals are allowed to make hardship withdrawals include the need to pay tuition, to pay medical bills that are not covered by insurance, and to purchase a primary residence. It is important to realize that some employers may not allow hardship withdrawals. Also, if the option is available and a person uses it, she will not be allowed to make contributions to her 401k account for six months afterward.

Individuals who are less than the age of 59 and a half and who stop working with an employer who managed their 401k accounts should thoroughly weigh the financial implications of getting a lump-sum distribution. According to the 401k withdrawal rules, if a person receives the lump sum, the transaction will be heavily penalized. The penalty is usually 10 percent of the withdrawal amount, and the money will be subject to federal tax at the same rate as a person’s other income.

Once a person reaches 70 and a half, the 401k withdrawal rules mandate that account holders must begin removing their money. The amount that must be taken from the account every year is referred to as the required minimum distribution (RMD). This amount is determined by figuring how much money a person has when she reaches 70 and a half and how long she is expected to live.

As the money invested was pre-tax income, it will be taxed when it is withdrawn at a person’s normal income tax rate. If a person does meet the RMD requirements for a given year, the 401k withdrawal rules mandate a penalty. That penalty will come in the form of a 50-percent tax on the amount that should have been withdrawn but wasn’t. According to the IRS, the penalty may be waived if the account owner establishes that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall.