Distributions from qualified plans are limited to a few special events by the Internal Revenue Code (IRC). While these restrictions are occasionally frustrating for plan participants, the restrictions are part of a two-sided approach to get Americans to prepare for their retirement years. In order to encourage more contributions and better savings habits, the government has given qualified retirement plans preferential tax treatment; people can save and defer paying taxes until they retire or withdraw their funds. But part of accumulating an adequate retirement account is also making sure that the contributions stay in the plan. As a result, the government also limits your ability to withdraw your money except in special circumstances.
When can you take a distribution?
The possible qualifying events are listed below, but read on to understand all the restrictions and limitations.
- Retirement
- Separation from Service (i.e. you are no longer working for your company)
- Pre-Retirement In-Service Distributions (Age 59 1/2+)
- Financial Hardship
- Required Minimum Distributions
- Distributions from Unrestricted Sources (i.e. Rollover from Prior Employer)
Distribution Option Details:
Retirement and Separation from Service: If you are no longer working for the company that sponsors your plan, you have several options:
- Leave your money in your plan: You may be allowed to keep your money in your plan if your vested balance is over $5,000 (or over the plan's forceout limit). If you do leave your money in your plan, be sure to keep your contact information current so that you continue to receive account statements and important plan notifications.
- Cash Out: You can request your vested balance be issued to you directly. This is a taxable event and will impact your taxable income for the year in which the distribution is received (note rules differ for Roth contributions). In most cases, your plan provider will be required to withhold 20% for federal income taxes and any required state income taxes from your check. Your final federal and state income taxes will depend on your income tax bracket. Note that your distribution amount will be added on top of your ordinary income so your distribution will typically be subject to your highest marginal tax bracket. In addition, if you take a distribution prior to age 59 1/2, the IRS will assess a 10% penalty for early withdrawal (some exceptions apply).
- Rollover to new employers plan: If your new employer has a plan, you may be able to rollover your account to your new employer's plan. Before you request a distribution, be sure you check with your new employer to make sure new employees can rollover their accounts. Your new employer will also need to tell you who your rollover check should be made payable to and where the check needs to be sent. Significantly, if you rollover your account to a qualified plan, you will preserve the tax deferred status and avoid any early withdrawal penalty taxes. Rollovers will not increase your taxable income.
- Rollover to an IRA: You may also rollover your account to an Individual Retirement Account (IRA). A rollover to an IRA will also preserve your account's tax deferred status and avoid any early withdrawal penalty taxes.
Pre-Retirement In-Service Distributions: This option is available in some retirement plans (check your Plan Highlights on https://myplanconnection.com to confirm availability in your plan). When available, it is open to people who are at least age 59 1/2. Some plans require additional service or may delay availability past age 59 1/2. If this is available in your plan, you have the same distribution options as separation from service withdrawal (except rollover to new employer plan).
Financial Hardship: Some plans allow participants to take a distribution of some portion of their account (typically only employee contributions) in the event of an immediate and heavy financial need. Check your Plan Highlights on https://myplanconnection.com to confirm availability in your plan. If this type of distribution is available to your plan, you will need to provide documentation showing that you have a financial hardship and certify that you do not have other means to satisfy the financial need. The types of events that qualify as an "immediate and heavy financial need" are limited. See our article on Hardship Distributions for more details.
Required Minimum Distributions: As of 1/1/23, once you are 73 and are no longer employed, you must take a Required Minimum Distribution (RMD). The first year you are required to take an RMD, you can delay distribution until April 1 of the following year. For all subsequent years, you must take your RMD prior to December 31. If you do not take your RMD by the required deadline, your late RMD will be taxed at a rate of 50%. The RMD amount is based on the preceding December 31 value of your account and the life expectancy tables.
Distributions from Unrestricted Sources: Some plans allow participants to take a distribution at any time of money that previously qualified for a distribution. For instance, if you rolled over your account from a prior employer, you could have taken that money as a cash out when you terminated from employment with your prior employer. Instead, you chose to rollover that money to a new employer. Since that "rollover" was previously distributable, your current employer's plan may allow you to distribute that money at any time. Note that these types of distributions would be restricted only to those funds in your "Rollover Source."
Any tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein. BlueStar Retirement Services, Inc. This bulletin is published as a general informational source. This information is general in nature and is not intended to constitute legal advice in any particular matter. BlueStar Retirement Services, Inc. does not warrant and is not responsible for errors or omissions in the content of this report.