The distribution of funds from a 401(k) plan, also known as a qualified retirement plan under Internal Revenue Code (IRC) Section 401(a), involves specific rules and timelines established by the IRS. Upon termination of employment, participants have options regarding the handling of their 401(k) accounts.
1. **Leave the funds in the plan:** This option allows the participant to retain their funds in the 401(k) plan indefinitely, continuing to accrue potential investment earnings tax-deferred. However, if the participant is under age 59½ and not disabled, withdrawals prior to that age may be subject to a 10% early withdrawal penalty imposed by the IRS, in addition to federal and state income taxes.
2. **Rollover to another qualified plan:** Participants can transfer their 401(k) funds directly to another qualified retirement plan, such as an IRA or a new employer’s 401(k) plan, without incurring any tax or penalty. This option preserves the tax-deferred status of the funds and allows for continued tax-advantaged growth.
3. **Cash out the funds:** Participants can choose to withdraw their 401(k) funds as a lump sum or in installments. Withdrawals prior to age 59½ (or 55 if the funds are used to purchase a first home) are subject to the aforementioned 10% early withdrawal penalty and applicable federal and state income taxes. However, if the participant has reached age 59½ or meets certain exceptions, such as disability or separation from service, they may be able to access their funds without penalty.
4. **Required minimum distributions:** Once an individual reaches age 72 (or 70½ if they were born before June 30, 1949), they must begin taking required minimum distributions (RMDs) from their 401(k) account each year. Failure to withdraw the required amount may result in a 50% excise tax penalty on the shortfall. The RMD calculation is based on the account balance as of December 31 of the preceding year and the participant’s life expectancy.
It’s important to consider the specific rules and implications of each option based on individual circumstances, including age, tax bracket, investment goals, and financial situation.
60-Day Rollover Limit
When you leave a job, you have 60 days to roll over your 401(k) savings to a new account. This 60-day window starts on the day you receive your distribution from your old plan.
- If you don’t roll over your savings within 60 days, the distribution will be taxed as income.
- You may also have to pay a 10% early withdrawal penalty if you’re under age 59½.
It’s important to remember that the 60-day rollover limit applies to each individual distribution. So, if you receive multiple distributions from your old 401(k), you have 60 days to roll over each distribution separately.
| Distribution Date | 60-Day Rollover Deadline |
|---|---|
| January 10, 2023 | March 11, 2023 |
| February 15, 2023 | April 16, 2023 |
The 120-Day Period for Repayment
When you leave a job, you have 60 days to roll over your 401(k) to a new account. If you miss this deadline, you can still roll over the money, but you will have to pay taxes and penalties on it.
The 120-day period for repayment begins on the day you receive the distribution from your old 401(k). During this time, you can roll over the money to any eligible retirement account, such as an IRA, a new 401(k), or a 403(b). If you do not roll over the money within 120 days, you will have to pay taxes and penalties on it.
The taxes and penalties for failing to roll over a 401(k) distribution are significant. You will have to pay income taxes on the amount of the distribution, and you will also have to pay a 10% early withdrawal penalty if you are under age 59 ½. These taxes and penalties can add up to a significant amount of money, so it is important to roll over your 401(k) distribution within 120 days.
Required Minimum Distributions (RMDs)
When you reach age 72, you must start taking Required Minimum Distributions (RMDs) from your traditional IRAs and 401(k)s. The RMD amount is calculated based on your account balance at the end of the previous year and your life expectancy.
Calculating Your RMD
The formula for calculating your RMD is as follows:
- RMD = Account Balance / Life Expectancy Factor
The life expectancy factor is determined by the IRS and is based on your age. You can find the life expectancy factor for your age on the IRS website.
Avoiding Penalties
If you fail to take your RMD by the deadline, you will be subject to a 50% penalty on the amount that you should have withdrawn. This penalty can be very costly, so it is important to be aware of your RMD requirements and to take your distributions on time.
Rolling Over Your RMD
You can avoid taking your RMD by rolling it over to another qualified retirement account, such as an IRA. However, you must complete the rollover by the end of the calendar year in which you take the distribution. If you do not roll over your RMD by the deadline, you will be subject to the 50% penalty.
There are some exceptions to the RMD rules. For example, you do not have to take RMDs from Roth IRAs or 401(k)s if you are still working and under age 72. However, you will have to start taking RMDs once you retire or reach age 72, whichever comes first.
RMD Table
The following table shows the RMD withdrawal ages and the penalty-free rollover period.
| Age | RMD Withdrawal Age | Penalty-Free Rollover Period |
|---|---|---|
| 72 | 72 | December 31 of the following year |
| 73 | 73 | December 31 of the following year |
| 74 | 74 | December 31 of the following year |
| 75 | 75 | December 31 of the following year |
| 76 | 76 | December 31 of the following year |
| 77 | 77 | December 31 of the following year |
| 78 | 78 | December 31 of the following year |
| 79 | 79 | December 31 of the following year |
| 80 | 80 | December 31 of the following year |
| 81 | 81 | December 31 of the following year |
| 82 | 82 | December 31 of the following year |
| 83 | 83 | December 31 of the following year |
| 84 | 84 | December 31 of the following year |
| 85 | 85 | December 31 of the following year |
| 86 or older | 86 | December 31 of the current year |
How Long Do You Have to Roll Over Your 401k?
When you leave a job, you may have the option to roll over your 401(k) to another account. A rollover is a tax-free way to move your 401(k) assets to another qualified retirement plan, such as an IRA or a new employer’s 401(k) plan.
Beneficiary Rollover Options
- Spouse: If your spouse is the beneficiary of your 401(k), they can roll over the assets into their own IRA or 401(k) plan.
- Non-spouse beneficiary: If a non-spouse is the beneficiary of your 401(k), they have two options:
- Roll over the assets into their own IRA.
- Take a lump-sum distribution and pay taxes on the entire amount.
Rollover Deadline
The deadline for rolling over your 401(k) is 60 days after the date you receive the distribution from your former employer. If you miss the deadline, you will have to pay taxes on the entire amount of the distribution, and you may also be subject to a 10% early withdrawal penalty if you are under age 59½.
Avoiding Taxes and Penalties
To avoid taxes and penalties, it is important to roll over your 401(k) assets as soon as possible after you receive the distribution. You can do this by:
- Direct rollover: This is the simplest way to roll over your 401(k) assets. Your former employer will send the distribution directly to your new IRA or 401(k) plan.
- Indirect rollover: If you receive the distribution in the form of a check, you can roll it over yourself by depositing the check into your new IRA or 401(k) plan within 60 days.
Table: Rollover Deadlines
| Beneficiary | Rollover Deadline |
|---|---|
| Spouse | 60 days |
| Non-spouse | 60 days |
So, whether you’re planning a career pivot, enjoying a well-deserved retirement, or somewhere in between, remember that your 401k is there for you. Keep in mind the time limits and rules we covered, and don’t hesitate to consult with a financial advisor if you need guidance. Thanks for stopping by! Be sure to check back in the future for more in-the-know articles on all things personal finance.