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How Does a 401(k) Work When You Retire?


After retirement you can start withdrawing the money you have accumulated over the years in your 401(k). However, a number of rules govern retirees’ 401(k) distributions. For instance, in most cases to avoid penalties you have to wait until after age 59.5 to retire and start taking money out. At any age, retirees owe federal income taxes on distributions from regular 401(k) accounts, although Roth 401(k) distributions escape taxation. Another rule is that, after age 70.5 or 72, depending on when they were born, retirees must start taking mandatory minimum distributions from their 401(k) plans every year.

A financial advisor can help you decide how to tap your retirement funds.

Basics of 401(k) Distributions

If your employer offers a 401(k) retirement plan you can contribute to it with pre-tax earnings while you are working and get valuable tax deductions. Many employers match your contributions, which can significantly boost a retirement savings plan. Investment gains from assets in a 401(k) also accumulate tax-free.

However, like most matters related to taxation, you have to follow a lot of rules when withdrawing from a 401(k). The IRS encourages following these rules by imposing penalties for violations. Some penalties can be exceptionally burdensome, so it pays for someone contemplating retirement to understand in advance the rules for withdrawing from 401(k) accounts.

How 401(k) Distributions Work

The mechanics of 401(k) distributions are generally simple although details may vary by plan. Usually, a 401(k) owner can simply log onto their online account and transfer funds to their checking or other spending account. Another option is to write, call or visit the plan administrator and request a check. You can take a distribution as a lump sum single payment or in periodic smaller amounts.

You will still owe income taxes on distributions after you retire, and plans do not withhold these taxes when account owners request distributions. So it’s a good idea to set aside some of the amount withdrawn to pay taxes. And once you get beyond the basic mechanics, things get more complicated. Your age is one important factor to consider.

Age Considerations with 401(k) Distributions

A 401(k) plan can be a powerful help to retirement savers, but they work best if you don’t plan to stop working much before traditional retirement age. That’s because withdrawals from a 401(k) taken before age 59.5 usually are subject to a 10% penalty in addition to the regular income taxes imposed on all regular 401(k) withdrawals.

To avoid the 10% penalty, don’t withdraw before age 59.5. If you do take money out before 59.5, you can avoid penalties as well as taxes by rolling over the full amount withdrawn into another retirement account within 60 days.

An exception to the 10% penalty applies if you are unemployed. If you lose your job, you may be able to withdraw from your 401(k) without penalty as soon as age 55. A few other exceptions, such as becoming disabled, may also let you avoid the penalty when withdrawing before 59.5.

Required Minimum Distributions

how does a 401k work when you retire

In addition to affecting when you can take distributions without penalty, age comes into play later on. If you are born after July 1, 1949, then after you turn 72 you must take Required Minimum Distributions (RMDs) from your 401(k) every year. People born before that date have to begin RMDs at age 70.5. You have to take RMDs when you reach the specified age even if you are not retired yet.

The annual amounts of RMDs are generally calculated to distribute the entire contents of your 401(k) by the end of your expected life span. These withdrawals are mandatory, with stiff penalties for failure to comply. If you don’t withdraw the full amount of the RMD by the due date, the IRS can levy a fine equal to 50% of the distribution you should have taken.

The Bottom Line

how does a 401k work when you retire

A number of rules govern how retirees are supposed to take distributions from their 401(k) accounts. To avoid a 10% penalty, they generally have to wait until after turning age 59.5 or, if unemployed, age 55. Also, they must start taking Required Minimum Distributions every year, beginning the year they turn 70.5 if born before July 1, 1949, and age 72 if born after that date. Failing to take an RMD can comes with a heavy penalty equal to half the amount that was supposed to have been distributed.

Retirement Tips

  • A financial advisor can help you sort through your options for withdrawing from a 401(k) in retirement. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • You can get a read on how much money you’ll need for a secure retirement using SmartAsset’s retirement calculator. This free online tool takes into account where you live, how much you make, your birth year, when you plan to start taking Social Security benefits and other factors to tell you how much income you’ll need to live comfortably after you stop working.

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