Understanding 401(k) Withdrawal Rules

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) account.

Before age 59½, an employee faces an IRS penalty if they withdraw money from a 401(k) account. The IRS allows penalty-free withdrawals, called qualified distributions, from retirement accounts after age 59½.

At that time, individuals are also permitted to convert their company-sponsored 401(k) into a more flexible individual retirement account (IRA). Withdrawals from a 401(k) are mandated after age 73 or 75, depending on the year you were born, and are called required minimum distributions, or RMDs.

401(k) Withdrawals After 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—including early withdrawal penalties and taxes such as federal income tax, a 10% penalty on the amount that you withdraw, and relevant state income tax.

Most Americans retire in their mid-60s. There’s a little more flexibility offered with retirement savings plans, including the company-sponsored 401(k). 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 old.

If you retire—or lose your job—when you are age 55 but not yet 59½, you can avoid the 10% early withdrawal penalty for taking money out of your 401(k); however, this only applies to the 401(k) from the employer that you just left. Money that is still in an earlier employer’s plan is not eligible for this exception—nor is money in an IRA.

How To Take 401(k) Distributions

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

When you take distributions from your 401(k), the remainder of your account balance remains invested according to your previous allocations. This means that the length of time over which payments can be taken, and the amount of each payment, 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 traditional 401(k) funds, distributions will be treated as taxable earnings for that year, on top of any other money that you made.

On the other hand, if you have a designated Roth account, 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 years.

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 a previous 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 distribution.

If you do not need your savings immediately after retirement, then there’s no reason not to let your savings continue to earn investment income. As long as you do not take any distributions from your 401(k), you are not subject to any taxation.

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 was previously 72 before Congress passed SECURE 2.0 in December 2022.

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 RMD.

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 retirement funds, you’ll need to roll over your account(s) into an IRA. Previously, you could contribute to a Roth IRA indefinitely but could not contribute to a traditional IRA after age 70½; however, under the new Setting Every Community Up for Retirement Enhancement (SECURE) Act, you can now contribute to a traditional IRA for as long as you like.

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 earned from either investments or your Social Security check, though certain types of alimony payments may qualify.

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 income.

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 IRA.

Traditional IRA vs. Roth IRA

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 distribution.

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—with Roth IRAs, you pay taxes upfront.

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 IRA.

The Bottom Line

Rules controlling what you can do with your 401(k) after retirement are very complicated, 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.