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401(k) Withdrawal Rules: What You Need To Know

401(k) Withdrawal Rules: What You Need To Know

May 08, 2024

Qualified distributions are allowed at age 59½.  That being said, there are 401(k) withdrawal rules for those who invest in a 401(k) workplace retirement plan and want to take withdrawals without incurring a penalty. Generally speaking, you may withdraw funds from your account at any time. However, should you do so before you are age 59½, you may face an IRS charge of 10%1.

According to 401(k) withdrawal rules, penalty-free withdrawals (called qualified distributions) are allowed once you reach age 59½1. And, after age 72 or 74, depending on the year you were born, you must take the required minimum distribution (RMD) from either a 401(k) or an individual retirement account (IRA)2.

KEY TAKEAWAYS

  • 401(k) withdrawal rules affect when account holders can take withdrawals without penalty.
  • If you retire after age 59½, you can start taking withdrawals without paying an early withdrawal penalty.
  • If you don’t need the money, you can let your savings sit and continue to grow tax deferred (though you won’t be able to contribute).
  • To keep contributing, you’ll need to roll over your 401(k) into an individual retirement account (IRA) and have earned income that you can add to the account.
  • With both a 401(k) and a traditional IRA, you will be required to take minimum distributions starting at age 73 or 75, depending on the year you were born2.

401(k) Withdrawals Before Age 59½

Tax-advantaged retirement accounts, such as 401(k)s, exist to ensure that you have enough income when you get old, finish working, and no longer receive a regular salary.

From time to time, you may be eager to tap into your funds before you retire; however, if you succumb to those temptations, you will likely have to pay a hefty price. This can include early withdrawal penalties and taxes: federal and state income taxes and a 10% penalty on the amount that you withdraw1.

Most Americans retire in their mid-60s, and the Internal Revenue Service (IRS) allows you to begin taking distributions from your 401(k) without a 10% early withdrawal penalty as soon as you are 59½ years old1. But you still have to pay taxes on your withdrawals.

Exception: The Rule of 55

If you retire, lose your job, or leave to take a new job when you are age 55 or over (but not yet 59½), you can avoid the 10% early withdrawal penalty for taking money out of your 401(k). The so-called Rule of 55 that allows this applies if a worker takes a distribution as early as the year that they turn 55 and leaves their employment.

 However, this only applies to the 401(k) from the employer that you just left. Money that is still in a previous employer’s plan is not eligible for this exception—nor is money in an IRA1.

How To Take 401(k) Withdrawals

A 401(k) plan is an employer-sponsored retirement account that allows employees to contribute a portion of their salary before IRS tax withholding. Companies commonly match a percentage of the employee's contribution and add it to the 401(k) account3.

Depending on your company’s rules, when you retire, you may elect to take regular distributions in the form of an annuity, either for a fixed period or over your anticipated lifetime or take nonperiodic or lump-sum withdrawals.

When you take withdrawals from your 401(k), the remainder of your account balance continues to be invested according to existing allocations. This means that the length of time over which withdrawals can be taken, and the amount of each withdrawal depend on the performance of your investment portfolio.

Taxes on 401(k) Distributions

If you take qualified distributions from a traditional 401(k), all distributions are subject to ordinary income tax. Contributions were deposited from your paycheck before being taxed, deferring the taxation process until the withdrawal date. In other words, when you eventually tap into your 401(k) funds, distributions are treated as taxable earnings for that year, on top of any other money that you make4.

On the other hand, if you have a designated Roth account within a 401(k) plan, you have already paid income taxes on your contributions, so withdrawals are not subject to taxation. Roth accounts allow earnings to be distributed tax free as well, as long as the account holder is over age 59½ and has held the account for at least five years5.

Keeping Your Money in a 401(k)

You are not required to take distributions from your account as soon as you retire. While you cannot continue to contribute to a 401(k) held by your former employer, your plan administrator is required to maintain your plan if you have more than $5,000 invested. Anything less than $5,000 will likely trigger a lump-sum distribution6 1.

If you do not need your savings immediately after retirement, then let them continue to earn investment income in the 401(k). As long as your money remains in your 401(k), it is not subject to any taxation.

IMPORTANT: If your account has from $1,000 to $5,000, your company is required to roll over the funds into an IRA if it forces you out of the plan—unless you opt to receive a lump-sum payment or roll over the funds into an IRA of your choice7.

Required Minimum Distributions

While you don’t need to start taking distributions from your 401(k) the minute you stop working, you must begin taking required minimum distributions (RMDs) when you turn 73, if you were born between 1951 and 1959, and 75 if you were born in 1960 or later. The age for RMDs had been 72 until Congress passed SECURE 2.0 in December 20222.

If you wait until you are required to take your RMDs, then you must begin withdrawing regular, periodic distributions calculated based on your life expectancy and account balance. While you may withdraw more in any given year, you cannot withdraw less than your RMD8.

Converting a 401(k) to an IRA

You cannot contribute to a 401(k) after you leave your job. So, if you want to continue adding money to your tax-advantaged retirement funds, you’ll need to roll over your account(s) into an IRA7

Previously, you could contribute to a Roth IRA indefinitely but could not contribute to a traditional IRA after age 70½; however, the Setting Every Community Up for Retirement Enhancement (SECURE) Act changed the law so you can now contribute to a traditional IRA for as long as you like9 10.

Keep in mind that you can only contribute earned income, not gross income, to either type of IRA. So, this strategy will only work if you have not retired completely and still earn “taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment,” as the IRS puts it. You can’t contribute money from either investments or your Social Security check, though certain types of alimony payments may qualify11.

How To Rollover Funds

To execute a rollover of your 401(k), you can ask your plan administrator to distribute your savings directly to a new or existing IRA. Alternatively, you can elect to take the distribution yourself; however, in this case, you must deposit the funds into your IRA within 60 days to avoid paying taxes on the income7.

Traditional 401(k) accounts can be rolled over into either a traditional IRA or a Roth IRA, whereas designated Roth 401(k) accounts must be rolled over into a Roth IRA12.

Traditional IRA and Roth IRA Withdrawal

Like traditional 401(k) distributions, withdrawals from a traditional IRA are subject to your normal income tax rate in the year when you take the distribution4.

Withdrawals from Roth IRAs, on the other hand, are entirely tax free if they are taken after you reach age 59½ (or see out a five-year holding period, whichever is later).

However, if you decide to roll over the assets in a traditional 401(k) to a Roth IRA, you will owe income tax on the full amount of the rollover. That's because with Roth IRAs, you pay taxes upfront (and you haven't yet paid taxes on contributions made to your 401(k)5).

Traditional IRAs are subject to the same RMD regulations as 401(k)s and other employer-sponsored retirement plans; however, there is no RMD requirement for a Roth IRA1 13.

Can I Take All My Money Out of My 401(k) When I Retire?

You are free to empty your 401(k) as soon as you reach age 59½—or 55, in some cases. It’s also possible to cash out earlier, although doing so would trigger a 10% early withdrawal penalty1.

How Long Does It Take To Get a 401(k) Distribution?

Times can vary, depending on who administers the account. For a more precise time frame, contact the HR department of the company for which you worked or the financial institution managing the funds.

What Are My 401(k) Options After Retirement?

Generally speaking, Retirees with a 401(k) have the following choices:

  • Leave your money in the plan until you reach the age when you start to take required minimum distributions (RMDs)
  • Convert the account into an individual retirement account (IRA)
  • Start cashing out via a lump-sum distribution, installment payments, or purchasing an annuity through a recommended insurer.

The Bottom Line

Rules controlling 401(k) withdrawals and what you can do with your 401(k) after retirement are very complicated and shaped by both the IRS and the company that set up the plan. Consult your company’s plan administrator for details. It may also be a good idea to talk to a financial advisor before making any final decisions about your retirement account.

Internal Revenue Service. “401(k) Resource Guide — Plan Participants — General Distribution Rules.” https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules

  1. U.S. Congress. "H. R. 2617," Page 831. https://www.congress.gov/117/bills/hr2617/BILLS-117hr2617enr.pdf
  2. Internal Revenue Service. "401(k) Plan Overview." https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
  3. Internal Revenue Service. “401(k) Plans.” https://www.irs.gov/retirement-plans/401k-plans
  4. Internal Revenue Service. "Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs)." https://www.irs.gov/publications/p590b
  5. Internal Revenue Service. "Retirement Topics - Termination of Employment." https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-termination-of-employment
  6. Internal Revenue Service. “Rollovers of Retirement Plan and IRA Distributions.” https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions
  7. Internal Revenue Service. “Retirement Topics — Required Minimum Distributions (RMDs).” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
  8. Internal Revenue Service. "Retirement Topics - IRA Contribution Limits." https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
  9. U.S. Congress. “H.R.1994 — Setting Every Community Up for Retirement Enhancement Act of 2019.” https://www.congress.gov/bill/116th-congress/house-bill/1994/text
  10. Internal Revenue Service. “Topic No. 451, Individual Retirement Arrangements (IRAs).” https://www.irs.gov/taxtopics/tc451
  11. Internal Revenue Service. “Rollover Chart.” https://www.irs.gov/pub/irs-tege/rollover_chart.pdf
  12. Internal Revenue Service. “Traditional and Roth IRAs.” https://www.irs.gov/retirement-plans/traditional-and-roth-iras