Distributions From an Employer-Sponsored Retirement Plan

A distribution from an employer-sponsored retirement plan, such as a 401(k) or 403(b), is a withdrawal of funds from a participant’s account. This money may include your contributions, employer contributions, and any investment earnings. The availability and type of distribution depend on your employment status, age, and the specific terms outlined in your plan’s documents.

Types of Distributions Available

Participants have several options when accessing funds from an employer-sponsored retirement plan. A lump-sum distribution provides the full vested balance in a single payment, offering immediate access to funds but often resulting in significant immediate tax consequences. In contrast, periodic payments, such as an annuity or regular installments, provide a predictable income stream over a set period or for life.

A rollover moves funds from one retirement account to another, preserving their tax-deferred status. A direct rollover, also called a trustee-to-trustee transfer, is where the plan administrator sends the money directly to a new retirement plan or an Individual Retirement Arrangement (IRA). For an indirect rollover, the plan issues a check to the participant, who has 60 days to deposit the funds into another retirement account to avoid it being treated as a taxable distribution.

Some plans permit in-service distributions while a participant is still employed, often after reaching age 59½. Plans are not required to offer these, and some may allow withdrawals of certain contributions, like after-tax amounts, at any time. The specific rules are detailed in the plan’s governing documents.

A hardship withdrawal may be an option for those with an “immediate and heavy financial need,” as defined by the IRS. This can include costs for medical care, purchasing a principal residence, preventing eviction, or paying for tuition. Hardship distributions are taxable, not eligible for rollover, and considered a last resort.

Many plans also allow participants to take a loan against their account balance. A loan is not a taxable distribution if repaid on time, usually within five years. Federal rules limit borrowing to the lesser of $50,000 or 50% of the vested account balance. A defaulted loan is treated as a taxable distribution and may be subject to penalties.

Tax Consequences of a Distribution

For pre-tax retirement accounts like a traditional 401(k), distributions are taxed as ordinary income in the year received. The withdrawn amount is added to your other income and taxed at your applicable federal and state income tax rates.

A 10% early withdrawal penalty applies to the taxable portion of a distribution taken before you reach age 59½. For example, if a 45-year-old takes a $20,000 distribution, they would owe ordinary income tax on that amount plus an additional $2,000 penalty. This additional tax is reported on IRS Form 5329.

Several exceptions to the 10% penalty exist. The penalty is waived for:

• Distributions made after the account owner’s death, total and permanent disability, or terminal illness.
• Qualified birth or adoption expenses up to $5,000.
• Withdrawals to pay for medical expenses exceeding 7.5% of your adjusted gross income (AGI).
• Distributions made under a Qualified Domestic Relations Order (QDRO) in a divorce.
• Withdrawals after separating from service during or after the year you turn 55.
• Withdrawals by victims of domestic abuse, up to the lesser of $10,000 or 50% of the vested balance.
• Distributions for those in federally declared disaster areas, up to $22,000.
• Withdrawals for certain emergency expenses, up to $1,000 per year.

If you take a distribution that is eligible for a rollover but do not process it as a direct rollover, the plan administrator must withhold 20% for federal income taxes. This withholding is a prepayment of your tax liability, not the final tax owed. Your actual tax liability could be higher or lower than the amount withheld.

Required Minimum Distributions

Required Minimum Distributions (RMDs) are mandatory annual withdrawals that ensure individuals eventually pay taxes on tax-deferred savings. Participants must begin taking RMDs by April 1 of the year after they reach age 73.

An exception exists for individuals still working for the employer that sponsors their plan. If the plan allows and the individual is not a 5% owner of the business, they can delay their first RMD until April 1 of the year after they retire. This exception applies only to the plan of the current employer; RMDs must still be taken from IRAs and plans of former employers.

The RMD amount is calculated annually based on the account balance at the end of the previous year and a life expectancy factor from the IRS’s Uniform Lifetime Table. For example, to calculate the RMD for 2025, you would use the account balance as of December 31, 2024, and divide it by the factor for your age in 2025. The plan custodian can often calculate this amount for you.

Failing to take the full RMD by the December 31 deadline results in a 25% tax penalty on the amount that should have been withdrawn. The IRS may reduce this penalty to 10% if the mistake is corrected in a timely manner.

The Process for Taking a Distribution

The process for taking a distribution begins by contacting your plan administrator, which may be your employer’s human resources department or the financial institution managing the plan. They will provide the necessary forms and explain the options available under your plan.

You will need to specify the type of distribution you are electing, such as a lump-sum payment, direct rollover, or periodic payments. For some plans, spousal consent may be a legal requirement, which involves your spouse signing the form before a notary or plan representative.

After you submit the completed forms, the funds will be disbursed. The timeline for receiving the money or completing a rollover can range from a few business days to several weeks.

In the year after your distribution, the plan administrator will send you IRS Form 1099-R. This form reports details to you and the IRS, including the gross amount, the taxable amount, and any taxes withheld. You must use this information to report the distribution accurately on your tax return.