Senior couple in home office reviewing finances

When you participate in your employer’s retirement plan, you’re likely focused on how much to contribute and how to invest your money. The goal is to grow your account balance during your working years and build a nest egg that will help supplement your income when you retire. While you can withdraw your money after you retire, you may also be eligible to withdraw money before you retire. Withdrawing money from your retirement plan is called taking a distribution.

Are you eligible for a distribution?

Your retirement plan provides great tax advantages. In exchange for these tax benefits, the Internal Revenue Service (IRS) has established rules regarding when you can take a distribution and how distributions are taxed. There are many factors to consider before taking a distribution. Consider consulting with a financial professional and your tax advisor to determine a strategy that works for you.

There are several situations that may allow you to take a distribution from your retirement plan account:

  1. You change employers or retire
  2. You reach age 59½
  3. You experience a financial hardship
  4. You wish to pay expenses related to the birth or adoption of a child
  5. You reach age 72

Log in to your account and review your retirement plan communications for more information as not all of these options may be available in your plan.

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Tax Considerations

Generally, distributions from your pre-tax account are subject to federal and possibly state and local taxes in the year you receive the distribution. Additionally, the IRS requires that applicable federal income tax be withheld from your distribution. Most distributions taken before age 59½ will also be subject to a 10% penalty. The IRS has defined certain exceptions to this penalty. Qualified Roth distributions are tax-free.*

*To qualify for tax-free Roth distributions, you must be age 59½ or older and your Roth account must have been funded for at least five years. Qualified Roth distributions are available at any age if you become disabled or die.

When you change employers, retire or if you suffer a disability, you can take a distribution from your retirement plan account. If you meet the IRS definition of total disability, you won’t have to pay the 10% penalty. If you are under age 59½, you may have to pay a 10% penalty on your distribution amount, in addition to federal and possibly state and local taxes. If you die, your beneficiary can take a distribution from your account.

Depending on your plan’s rules, you may be able to:

  • Take a distribution of your entire account balance. This is often referred to as a lump-sum distribution.
  • Take your distribution over time, deciding how often and how much you would like to withdraw (subject to plan rules). This distribution type is referred to as an installment payment.
  • Take a portion of your account balance, or a partial distribution, and leave the remainder of your balance in the plan.
  • Move your balance to an IRA or another employer’s qualified plan. This is commonly called a rollover.
  • Leave your money in the plan where it can continue to be invested for your future.

Your plan may allow you to take an “in-service” distribution once you reach age 59½. In-service distributions allow you to withdraw money from the plan while you are still working. The distribution will be considered ordinary income and subject to applicable federal, state and local taxes, and the 10% penalty would not apply.

Your plan may allow you to take a hardship distribution for what the IRS calls “immediate and heavy” financial needs. These can include:

  • Medical expenses for you, your spouse, your beneficiary or dependents
  • Costs directly related to the purchase of your principal residence (excluding mortgage payments)
  • Tuition, related educational fees, and room and board expenses for the next 12 months of postsecondary education for you, your spouse, your children, your beneficiary or dependents
  • Payments necessary to prevent eviction from your principal residence or foreclosure on the mortgage on that residence
  • Funeral expenses for your spouse, children, beneficiary or dependents
  • Certain expenses to repair damage to your principal residence

The amount of the distribution is limited to the amount needed to cover the financial hardship. Additionally, you may need to show proof that you were unable to reasonably obtain funds from another source (e.g., a loan) to cover the financial hardship. Hardship distributions are generally subject to federal and possibly state and local taxes, as well as the 10% penalty if you are under age 59½.

Your plan may allow you to take a qualified birth or adoption distribution. If allowed in your plan, each parent can take up to a $5,000 distribution for the birth or adoption of a child. These distributions are taxable as ordinary income and not subject to the 10% penalty for those under age 59½.

Qualified birth or adoption distributions are an optional plan provision. Check your plan to determine if this distribution option is offered.

The IRS requires you to start taking annual distributions from both your pretax and Roth retirement plan accounts once you reach age 72.

Your first RMD must be taken by April 1, of the year following the year in which you turn age 72. Each year after that, your RMD must be taken by Dec 31. Your RMD is determined by applying a life expectancy factor set by the IRS to your account balance as of Dec 31 of the previous year. While your RMD is often calculated on your behalf, there are several resources available online that will help you estimate your RMD.