401k Distribution Rules

Frequently Asked Questions

1. QUESTION:
   Taking a 401K Distribution?
   What are the rules to take a distribution without penalty? I will be 59 1/2 on December 17. The sponsor needs to know by the 7th to do it this year. What happens if they cut the check on the 16th? Can I hold it until after the 17th?

   • ANSWER:
     If the money is cut before the 17th, it’s too early. The existence of the check is the problem, not whether or not you’ve cashed it.

     If you ask for the money in 2009, it’s subject to the penalty.

2. QUESTION:
   In 2009 tax rules, If I did not take RMD from my IRA and 401k in 2009, do I have to take twice in 2010?
   In 2009 I did not have to take my normal Required Minimum Distribution from my IRA or 401k. I did neither. In 2010 do I have to make up for that by taking twice the normal distribution from both accounts?

   • ANSWER:
     In 2009 there is a special waiver so that you do not need to take your RMD from your IRA or 401(k). You do not need to make up this RMD in subsequent years. Unless the waiver is extended, you simply begin taking your RMD as usual for the 2010 tax year.

3. QUESTION:
   What are the tax implications I face for not mailing my 401k distribution?
   In November of 2009 I decided to remove money sitting in a 401k from a previous employer and move it over to my account with my current employer. The money was sent to me via check. The check is made out to the new 401k financial institution with my current employer. I have neglected to mail the check to the new institution. I believe there is a rule that the money must be moved or you have to pay tax on it. Is that the case here as I have yet to move it and it has been almost 3 months? If I do move it over and I owe tax do I owe it for 2009 or for 2010? If I move it over and owe tax where does the money to pay the tax come from given that I would be depositing the full amount in the current employer 401k account?
   Additional details… I was given a 1099-R but it says that my taxable amount is [FAQ-QUESTION] and the distribution code is G (Direct rollover of distribution).

   • ANSWER:

4. QUESTION:
   Another 401k Rule Of Thumb?
   401k plans may request distributions of %, say in 25% increments. Then what may be a wise distribution for short term, medium term. long term. Also, are all 401k plans available for % adjustments and funds quarterly or monthly?

   • ANSWER:
     401K plans do not request you take any amount of money using percent as the calculation. Once you reach 70 1/2 you must follow the uniform lifetime table to determine the minimum you must take each year. There are no rules of thumb here. At 59 1/2 you can take as much or as little as you want without penalty. You just have to pay income tax on the money. Between age 59 1/2 and 70 1/2 you can do whatever you want. As a matter of fact, you can empty your 401k if you want to, pay the tax, and put the money someplace else. If you do this, you don’t have to worry about Minimum Required Distributions at age 70 1/2.

     You can also start taking money from a 401K before 59 1/2 using either the minimum distribution, amortization or annuitization method. As long as you follow the tables exactly, and don’t skip, increase, or reduce the amount until you reach 59 1/2, you can avoid the 10% early withdrawal penalty.

     The federal government established the Minimum Required Distribution (MRD) rule because they don’t want you to accumulate a large sum of money, defer taxation, and then pass the money to heirs. And then the heirs use some of it and pass it on again. In reality, the government has allowed you to grow money tax deferred and they want those taxes back. Most plans will directly deposit the withdrawal into a checking account monthly, quarterly , or annually. Remember there is 20% federal withholding on each withdrawal.

     Let’s look at an example. You are 70 1/2. You must make your first MRD by April 1st following the year you reach 70 1/2 if you are retired. If you are still working, the MRD does not begin from your current employer plan until April 1st following the year you retired. If you have more than one plan, only the plan with your current employer qualifies for the delay. All other plans must start April 1 following age 70 1/2. If you have 0,000 in your 401K, the table says your account must be empty in 27.4 years. The amount you must take is ,197. If you for example, only took ,000, you would have to pay a 50% excise tax penalty on the amount you failed to take, in this example ,197. The penalty is large because the government does not want people stretching the payments out over a longer period of time. You notice the calculation says 27.4 years. That means by age 97.

     So now you can do some paydown calculations if you want to try and make sure the account is empty by age 85 or 90. If longevity runs in your family, you can plan for longer, but most of my clients want the account empty by age 90. As long as the amounts are over the MRD, you can do what ever you want.

     The distribution the next year is calculated based on the balance in the account. So depending on what interest rate the account earned, this will determine the amount you need to take. The higher the rate of return the more you have to take. For example, at 8% the next year’s distribution would be ,414. But if the account had earned 10% instead of 8% in would be ,996. If the account earned 6% the amount would be less, ,832. Notice how the amount keeps increasing in subsequent years. The government is smart here as well. By taking the MRD, if the interest rate remains constant or higher, the amount you need to take each year is higher, thus pushing you into a higher tax bracket, (pay more tax). At age 80 the MRD is ,363.

     This is one of the tax traps regarding 401K’s. That ,996 in the example above is income. It gets added to your social security benefit, your spouse’s retirement income, social security and any other interest and dividends to determine how much of your social security benefit you need to report as income. If you and your spouse report over ,000 of income, including social security, 85% of the social security benefit must be reported and taxed as ordinary income. The government does not want to give you all your social security, if you have other income. They get some of it back by taxing it.

     The second big problem with the qualified plan (401K, IRA, etc.) is you have lost control of managing your tax bracket during retirement. I have many clients who are in higher tax brackets retired, then they were in when they worked. And since the government can change the rules, raising the tax brackets for example, it becomes even more difficult to calculate future distributions because we don’t know what the rules will be. Believe it or not, a few years ago there was an excess distribution tax of 15% if you decided to take too much. The government had put this rule in effect to stop people from taking large amounts, for example during years when tax brackets may have been lower. The rule was repealed. But, there is no telling what might be on the horizon if the government needs additional revenue. So once again, you really are not in control of your 401K, the government is.

     The MRD also applies to IRA’s 403B’s, and any oth

5. QUESTION:
   Retirement Distribution Confusion for 2010 Federal Tax?
   1) Let’s say that you withdrew 0 from your 401K and rolled it over to a Rollover IRA and then converted of 0 into Roth IRA. It appears like in the eyes of IRS, they consider both transactions as distributions (401K -> Rollover IRA, and Rollover IRA -> Roth IRA). So it turns out under IRS rule, my total distribution is 0 (0 + ) even though only is taxable as was converted from Rollover to Roth IRA. Is this correct?

   2) Another confusion is, you can get Retirement Savings Contribution Credit, but Turbo Tax asks you if you received any distribution from Retirement Plans in 2010. I think, I have to answer with 0 even though my before tax money is and my after tax money (which went into Roth IRA) is … So the actual amount is only 0, but I think I have to say my total distribution is 0 even though it doesn’t make sense. Am I correct?

   Please help. This tax is a pain in where you know what.
   Yes, the rollover took place WITHIN 60 DAYS so it would mean that amount is NOT distribution?

   • ANSWER:
     it is only a pain since you made it so
     first of all if you rolled over either a 401(K) or and IRA into another within 60 days it is not a distribution

     then if you actually took a distribution of 0 that would be taxable
     if you converted to the Roth, you would pay income tax on the , and early withdrawal penalty as well

6. QUESTION:
   401k 72(t) early distributions questions?
   I know this is a complicated subject, but help from knowledgeable people would be appreciated.

   1. Say I set up the proper 72t distributions and at age 59.5, there was still a lot of money in the account. Is this money handled normally from then on out (i.e. the normal withdrawal rules associated with the 401k as if I never did 72t distributions)?

   2. If I am in the middle of a 72t distribution plan, could I still withdrawal more funds (subject to the taxes + 10% penalty on the withdrawn money of course)?

   3. If I’m in the middle of a 72t distribution plan, and I get a new job with a 401k plan, could I contribute to that plan as normal?

   Thanks.
   I’m referring to the IRS guidelines, not to arbitrary things found in a given 401k plan. Please answer the questions with regards to the IRS guidelines assuming that the 401k plan itself will not pose further complications.

   • ANSWER:
     1. Yes, as long as you have received the payments for a minimum of five years. You can discontinue the periodic payment schedule and proceed normally.

     2. Yes, anyone over age 59.5 who takes a 401k distribution is not subject to the 10% penalty.

     3. Yes, there is no upper age limit set by the IRS for 401k contributions.

7. QUESTION:
   401k liquidation to save business & jobs?
   I have a small business that employees 35 people. We manufacture a product that’s sold almost 100% in new home construction. As you can imagine, the new home economy has devastated my business and we struggled to stay afloat during 2009. In order to help keep the doors open and “create or save” 35 jobs, I had to remortgage our home and liquidate my 401k to put cash into the business to cover payroll, utilities, and material purchases. While this action has helped save my business, it is now going to send me into more personal debt to pay my 2009 tax bill come April 15th. I can understand the IRS wanting their rightful taxes on the 401k money, but for that 401k distribution to also push me into a WAAAAY higher tax bracket than I would normally be in, is beyond reason to me. Am I missing something here? This one-time distribution pushed me from the 25% bracket into the 33% bracket which seems onerous since the funds were used to save my business and the jobs of 35 other people. Am I just toast on this, or is there an accepted (hardship?) rule that will help me?
   StephenW: Didn’t intend to insult you by making you think I didn’t want to pay taxes. As I stated, I accept the 10% penalty + taxes due since the money was invested pretax. It’s the push from my normal 25% bracket to the 33% bracket that is onerous.

   Maybe I should have:

   1) Kept my 401k and other personal savings in tact
   2) Pull my investment from the business
   3) Wait the 90-day claw-back period
   4) File business bankruptcy
   5) Let 35 people hit the public soup line

   This would have been a better plan for me personally.

   • ANSWER:
     You are just toast on this. This is how it works, and how it has always works. The accepted rule is that you must pay the tax. The hardship rule is that you can ask Congress to change the law, because that is what it would take for the IRS to be able to let you not pay the tax that the rest of us must pay when we take money from our 401K’s.

8. QUESTION:
   Is a Roth 401K @ age 24 a good idea?
   I have a regular 401k and a roth. I only allocate a small percentage of money to it but after reading up on it i’m starting thinking it’s more wise to increase my percentage on the regular 401k and stop contributing to the roth. With the 59 1/2 rule and applicable distributions, I don’t believe it’s necessary for me (who may not be with the company by age 59) to continue contributing to it.

   My only issue is i may be able to roll it over to another roth but I think I’d get more for my buck with the regular 401k contribs. Any advice in regards to the roth?

   • ANSWER:
     A Roth IRA is a good idea at ANY age. It is especially good if you think you will be retiring in a higher tax bracket than where you are now. If you save a lot of money for retirement, isn’t that the goal — to have a pile of money you can depend on?
     The Roth grows tax free, and when you take out the earning when you are old, the money is all tax free as well.

     I would keep contributing to both. If anything, if forced to choose, take a closer look at that 401k you have. Does your company match your input? Put in as much as you can to get their full match at least. But beyond that look at what you are investing in — are they really good companies or funds? Many 401ks offer mediocre choices. And many companies have very high fees.
     Look at:

     http://www.vanguard.com/us/insights

     and look closely at the truth about costs. You can see how much that company managing your portfolio is skimming off for itself and how much you are losing in earnings over time.

     I applaud you for being interested in this though. With 40+ years to grow, you can amass quite a fortune to retire on.

9. QUESTION:
   My mother has a 401k with her current employer. She is 65.?
   Since 59 1/2 is the age when you are allowed to take distributions without penalty, is she allowed to take some or all of the money out (obviously paying taxes on the withdrawal) even though she is still employed there? She has a 14k dental bill. FYI- She is not contributing to the plan (it currently offers no matching) at this time. Some have said once you’re 59 1/2 you can take out whatever you want (by IRS rule), others seem to think the employer can disallow any withdrawals as long as you are employed with them. What’s the correct answer?
   You see, I get conflicting answers…technically she’s of age to take the money, as much as she wants, right? But the wrinkle is she’s still employed there, so her employer’s plan might have some sort of restrictions on distributions while you’re still employed with the company…in fact I think my mother said the person handling the plan at her company (the bookeeper, it’s a small business) seemed to think there was some penalty or other restrictions….is this permitted or does the IRS code supercede any of the plan’s restrictions?

   • ANSWER:
     Age 59 1/2 is simply an IRS dictated age where a withdrawal can be taken without that infamous 10% early withdrawal penalty. It doesn’t mean that the employers have to allow an in-service withdrawal at that age. An employer still can allow for withdrawals only at distribution time. Or they can allow for inservice withdrawals but limit the amount only for specific hardship reasons and only to the extent of the employee contributions. IE if your mom only put in 10k of her own money then she could only take 10k out even if her account balance is 30k.

     All that being said…most plans begin allowing for distributions of all money types once the participants reach normal retirement age which is generally 65. Your mom should ask for a copy of the plans Summary Plan Description and look under the withdrawal and distribution options. It will be spelled out very clearly in there. Anything that anyone says on here is purely speculation and can’t be relied upon. You need that Summary Plan Description.

10. QUESTION:
    Personal Finance………..?
    1. Match the following words to its correct definition.
    A. General and progressive increase in prices
    B. Investment in which you are loaning money for a certain time period to the issuer
    C. Individual retirement account in which a person can set aside after-tax income up to a specified amount each year, earnings are tax-free, and tax free withdrawals may be made after age 59 1/2
    D. Distributions of profit a company pays you because you own stock in that corporation
    E. Supplemental retirement system in the United States
    F. Individual Retirement Account
    G. The amount of money you make on an investment in relation to the amount of time your money is invested stated as an annual percentage
    H. Quick and easy way to estimate how long it will take for you to double your money
    I. Type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pretax basis
    J. Retirement plan for certain employees of public schools, employees of certain tax-exempt organizations and certain ministers
    K. An exchange where security trading is conducted by professional stockbrokers
    L. The age at which someone stops working permanently
    M. Asset purchased for profit
    N. An arrangement to provide income to people when they are no longer earning income
    O. Collection of financial securities (stocks, bonds, cash) that is managed by a company or a person on behalf of many investors

    Rule of 72
    Dividend
    Mutual Fund
    Bond
    Stock Market
    Rate of Return
    Inflation
    Pension
    Retirement
    Social Security
    IRA
    Roth IRA
    401K
    403b
    Investment2.

    How do mutual funds reduce risk?
    A) They invest in stocks
    B) They provide investment diversification
    C) They use an investment manager
    D) None of the above

    3. Your grandpa is 62 and asks you if he is eligible to collect Social Security. What do you tell him?
    A) He could collect his full payment now.
    B) He could have started collecting at age 59 1/2.
    C) He can receive reduced payments now.
    D) None of the above.

    4. Which type of account is usually used when employees can have a matching contribution from their employer?
    A) Roth IRA
    B) Traditional IRA
    C) 401k
    D) 403b

    5. In the future, you and your friends plan to receive Social Security after you retire. At what age can you currently plan to receive full benefits?
    A) 59 1/2
    B) 62
    C) 65
    D) 67

    6. Which type of individual retirement account should you choose if you want your contributions to be tax deductible?
    A) Roth IRA
    B) Traditional IRA
    C) 401k
    D) 403b

    7. When you reinvest dividends,
    A) you will receive them by check
    B) you will receive them by direct deposit
    C) the dividends are deposited into a Certificate of Deposit
    D) the dividends are used to buy more shares of stock

    8. Bonds are known as
    A) fixed income investments
    B) equities
    C) dividends
    D) no load mutual funds

    9. When you purchase stock in a corporation
    A) you are loaning money to the corporation
    B) you are technically becoming a part owner of that corporation
    C) you do NOT earn the right to vote on the direction of the company
    D) you have to own the stock for at least one year before you are allowed to sell it.

    10. Which of the following is the oldest measure of the U.S. stock market and the most widely used indicator of stock market activity?
    A) The NASDAQ
    B) The S&P 500
    C) The Dow Jones Industrial Average
    D) The Russell 2000

    11. The total value of the securities a mutual fund owns divided by the number of shares outstanding is known as the mutual fund’s
    A) Face Value
    B) Net Asset Value
    C) Market Value
    D) Yield

    12. Mutual Funds called “load” funds charge a high flat fee whyou purchase the fund or sell the fund.
    A) True
    B) False

    13. TD Ameritrade is an example of a full-service brokerage company.
    A) True
    B) False

    14. Treasury bonds are considered to be more risky than owning stocks.
    A) True
    B) False

    15. A Roth IRA is beneficial because your withdrawls are tax-free.
    A) True
    B) False

    16. IRA stands for Important Retirement Assets
    A) True
    B) False

    • ANSWER:
      That’s a lot of questions. If you care to email me any particular ones you are having trouble with, I’d be glad to help you. Or, if you email me your answers, I’d be glad to check them over for you. Good luck.