Distribution refers to the process of taking money out of a 401(k) plan. When participants in the plan, who are typically employees, decide to take money out of their accounts, it is known as taking a distribution. This can occur upon reaching retirement age, which is defined by the plan and IRS regulations, typically at or after the age of 59½. Distributions can also occur under other circumstances, such as when a participant leaves an employer, becomes disabled, or faces a financial hardship that qualifies under the plan’s rules for an early distribution.
There are several types of distributions:
- Regular Distributions: Withdrawals made after reaching the age of 59½, which are subject to ordinary income tax but not the additional 10% early withdrawal penalty.
- Early Distributions: Withdrawals made before age 59½, which may be subject to both ordinary income tax and an additional 10% early withdrawal penalty, unless an exception applies.
- Required Minimum Distributions (RMDs): The IRS requires that participants begin taking distributions from their 401(k) starting at age 72 (as per the SECURE Act passed in 2019) to ensure that retirement funds are eventually subject to taxation. These distributions are calculated based on IRS life expectancy tables and the account balance.
- Hardship Distributions: Some plans allow for early withdrawals under certain financial hardships. These distributions are subject to taxes and potentially the 10% early withdrawal penalty.
- Rollover Distributions: Participants may move their 401(k) funds to another qualified retirement plan or an individual retirement account (IRA) without paying immediate taxes or penalties through a direct or indirect rollover.
The taxation and penalty implications of a distribution depend on the type of distribution, the age of the participant, and whether the distribution is rolled over to another tax-advantaged retirement account.