Understanding the rules for 401(k) withdrawal after 59 1/2

9 MIN READEditorial Policy

Key Takeaways

  • Most plans allow participants to withdraw funds from their 401(k) at age 59 ½ without incurring a 10% early withdrawal tax penalty

  • If you’re withdrawing pre-tax money, you’ll still pay taxes on your 401(k) withdrawal; but if you’re withdrawing Roth funds, you may not have to pay taxes on your contributions

  • Most plans allow participants to take a distribution from a rollover source at any time (i.e., money rolled into a plan from another qualified plan or IRA)

A 401(k) is a type of employer-sponsored investment account. It lets employees contribute a portion of their salary before the IRS withholds funds for taxes, which allows interest to accumulate faster to increase the employees’ retirement funds. 

If you have a 401(k), you could pay a penalty if you cash out before you turn 59 ½, also known as an “early withdrawal penalty.” The penalty does not apply to any funds rolled into an IRA or another employer’s plan and only applies to funds taken directly in cash. However, many plans permit participants to take penalty-free distributions after age 59 ½. 

401(k) withdrawal rules for people older than 59 ½

There are several types of 401(k) withdrawal types and related rules for each. However, many plans permit participants to take a distribution at the age of 59 ½ for two reasons: 

  1. You're permitted to withdraw funds from your 401(k) at this age without incurring a 10% early withdrawal tax penalty on your withdrawal amount, and

  2. ERISA regulations allow participants that reach age 59 ½ to withdraw deferrals from 401(k) plans (subject to plan provisions). 

While all plans require pre-tax deferral contributions, most also allow Roth, or post-tax, deferral contributions. While traditional 401(k) contributions offer tax-deferred savings, you’ll pay taxes when you take the money out of your account. For example, if you withdraw $15,000 from your 401(k) plan, you’ll have an additional $15,000 in taxable income that year. With a Roth 401(k), contributions are from post-tax dollars and aren’t taxed at withdrawal. Earnings on Roth 401(k) contributions may also be withdrawn tax-free, as long as you’ve held the account for five years.

If you’re still working after you turn 59 ½, your plan’s document could limit the amount you can withdraw while employed or even prevent you from making withdrawals until you terminate employment. The rules may also require you to work at a company for a specific number of years before your account becomes fully vested. With a fully vested account, all contributions from your employer may be available for withdrawal. 

Most plans allow participants to take any rollover source as a distribution (including money previously rolled into the plan from another qualified plan or IRA) at any time, but taking this amount in cash before age 59 ½ may result in a 10% penalty.

401(k) withdrawal rules for people between 55 and 59 ½

Most of the time, if you withdraw cash from your 401(k) before age 59 ½, you must pay a 10% penalty in addition to your regular income tax. However, in some circumstances, you can withdraw your savings without penalty at age 55 or older. To bypass the penalty, you cannot be a current employee of the company that sponsors the 401(k), and you must have left your employer during or after the calendar year you turned 55. Many people call this the “Rule of 55”. 

You should keep a few things in mind if you’re between 55 and 59 ½ years old and considering a 401(k) withdrawal from an old employer. For starters, it doesn't matter why your employment stopped. You can qualify for a penalty-free withdrawal if you quit, were fired, or were laid off. However, you must meet the requirement that mandates your employment must end in the calendar year you turn 55 or later.

The rule that requires you to be age 55 applies to the date your employment with a company stops—not the date you started taking 401(k) distributions. For example, if you retire at age 50 instead of waiting until 58 or later, you’ll need to pay the penalties for any withdrawals before you are 59 ½.

These early 401(k) withdrawal rules only apply to assets in 401(k) plans maintained by former employers and don’t apply if you’re still working for your employer. For example, an employee of Washington and Sons won’t be able to make a penalty-free cash withdrawal from their current 401(k) plan before they turn 59 ½. However, the same employee can make a withdrawal from a former employer’s 401(k) account and avoid the penalty on cash distributions if they terminate employment at age 55 or older.

Assets in an IRA have different rules about penalty-free early withdrawals. That means any funds you’ve rolled over from your 401(k) to an IRA won’t be eligible for a penalty-free early withdrawal. However, you could qualify for a different exemption based on the rules and regulations for IRAs. Consult your tax advisor to find which exemptions apply to your situation.

Also, you don’t need to be retired to avoid paying an early 401(k) withdrawal penalty. If you retire from a company at age 58 or later, you can access the savings in your 401(k) from that company with no penalty using the “rule of 55.” This fact will not change, even if you take a job with another business immediately after you retire.

Required 401(k) distributions

Starting in the calendar year you turn 73 years old, withdrawals from your 401(k) may become mandatory. The IRS requires the plan administrator for your company 401(k) to start sending you yearly payments from your account. The amounts of these payments are based on your life expectancy and the amount of money in your account. The IRS calls them required minimum distributions or RMDs. They make it more likely that 401(k) investors will receive all the money in their accounts and be able to use it before their deaths.

If you have more than one 401(k), you’ll need to take a separate RMD from each account. If you want to keep earning interest on your money, you can delay your first RMD until April 1 of the year after you turn 73 (or the year you become eligible to receive RMDs, whatever is later). In the years after that, you must begin receiving your payments by December 31.

A 401(k) is an excellent investment when you follow all the rules that come with it. It’s also an effective way for employers to attract outstanding employees. Human Interest can help you provide an affordable, full-service plan for your workers.

Vicki Waun, QPA, QKC, QKA, CMFC, CRPS, CEBS, is a Senior Legal Product Analyst at Human Interest and has over 20 years experience with recordkeeping qualified plans, along with extensive experience in compliance testing. She earned her BSBA in Accounting from Old Dominion University and is a member of ASPPA.

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