When do you have to start withdrawing from 401k

Tax-deferred retirement accounts like employer-sponsored 401(k) plans are designed to help people save for retirement. There are many benefits to saving for retirement through a 401(k). However, it’s important to understand some of the rules pertaining to 401(k) plans. One rule often overlooked is mandatory withdrawals or RMDs.

Mandatory withdrawals from a 401(k) are annual withdrawals made from a 401(k) required by the IRS. Starting at 72, the mandatory withdrawals are calculated using the IRS RMD worksheet. Amounts equal the balance of your 401(k) divided by a distribution period between 25.6 and decreasing annually to 1.9 when you reach 115. For example, if you have $1 million in your 401(k) when you turn 72, you divide $1 million by 25.6 giving you a mandatory withdrawal amount of $39,062.50 for that year.

Each annual amount must be withdrawn from the eligible account by December 31 of each year or be subject to stiff penalties.

To avoid this from happening to you, let’s go over in more detail what you need to know about mandatory withdrawals from your 401(k).

How to Calculate Your Mandatory Withdrawal Amount

Once you turn 72, you are required to withdraw a specific amount from your 401(k) each year. You must take out this amount by December 31 of each year to avoid penalties. Take out too little, and the remaining amount will still be penalized.

To make sure you are withdrawing the correct amount from your 401(k), the IRS provides a calculation so you can zero in on the exact amount you need to withdraw.

To get your annual amount, divide your 401(k) balance as of December 31 of the previous year by your life expectancy factor.

Your life expectancy factor is taken from the IRS Uniform Lifetime Table.

An exception to this requirement is if your spouse is the only primary beneficiary and they are 10 years younger than you, use the IRS Joint Life Expectancy Table instead.

How Are Mandatory Withdrawals Taxed?

Because you contributed to your 401(k) with tax-deferred income, the government still wants their share. The reason mandatory withdrawals are required is to ensure the income you contributed to your 401(k) doesn’t go without contributing to the greater good of Uncle Sam.

Just like other distributions during retirement, mandatory withdrawals are taxed as ordinary income.

Additionally, mandatory withdrawals count towards your overall annual taxable income. So if you are still working, these withdrawals from your 401(k) could lift you into a higher tax bracket.

Lastly, the tax obligations of mandatory withdrawals don’t stop with your federal taxes. State and local taxes may be applied to these withdrawals as well.

What Are the Penalties for Not Taking Mandatory Withdrawals?

Failing to withdrawal the required amount each year could cost you a pretty penny. Although the IRS has been waiting patiently to get their share of your retirement via income tax, they aren’t too patient once you reach 72.

Any mandatory amount that hasn’t been withdrawn from a 401(k) by December 31 of the applicable year will be subject to a 50 percent penalty.

If your calculated mandatory amount is $10,000 and you fail to withdraw it, you could lose $5,000 automatically.

It’s best to review your mandatory withdrawal amount at the beginning of each year and make a plan to withdraw that amount before the end of the year.

What Are the Exceptions to Mandatory Withdrawals?

Despite IRS imposing these mandatory withdrawals and penalties, there are scenarios that allow you to delay taking money out of a 401(k).

If you’re 72 and older and still working for the company that sponsors your 401(k) plan and don’t more than 5% of that company, you can delay your mandatory withdrawals.

However, if you leave that company, you will be required to begin taking mandatory withdrawals from that 401(k) plan.

Additionally, this exception only applies to the 401(k) plan held by that employer. Any old 401(k)s with former employers you still have are subject to mandatory withdrawals.

To avoid this, it’s best to periodically check for old 401(k)s and roll them over to your current 401(k) or IRA.

Mandatory Withdrawals From Other Retirement Accounts

The IRS mandatory withdrawal requirements don’t only apply to employer-sponsored 401(k) plans.

Traditional IRAs, SEP IRAs, SIMPLE IRAs, 403(b)s, and 457(b)s are all subject to the same mandatory withdrawal guidelines.

The only retirement account that does not require mandatory withdrawals is Roth IRAs. Since you pay taxes on the amount you contribute to a Roth IRA, the IRS has already received taxes on that amount.

Retirement accounts such as 401(k) help workers invest part of their paycheck for their golden years. The money contributed to a 401(k) is meant for retirement, and this is why the IRS makes it difficult for retirement savers to access their money before attaining the full retirement age. Usually, the younger you are, the fewer options you have to access your 401(k) money, but this changes when you reach the required retirement age.

Once you are 59 ½, you can take a 401(k) withdrawal without paying an early withdrawal penalty. However, you will still be required to pay taxes on the 401(k) withdrawal. If you are below 59 ½, you may be able to withdraw from your 401(k), but you may incur an early withdrawal penalty. An exemption to this requirement is if you leave your job when you reach age 55, when you may qualify to make a penalty-free withdrawal.

Withdrawing from 401(k) before Age 55

If you are younger than 55 and still work for your employer, you have two options to access your retirement savings. If your employer allows 401(k) loans, you may be allowed to borrow against your retirement savings to meet emergency financial needs or pay for college education. An alternative to 401(k) loans is a hardship withdrawal, which involves withdrawing money for immediate financial needs such as medical expenses, funeral expenses, or to prevent foreclosure on your primary residence.

If you lost your job and you need money for a financial emergency, you could consider taking a withdrawal from your 401(k) account. However, withdrawing 401(k) money should be your last resort since this decision could have a huge impact on your retirement. Early withdrawals are taxed as income and you could pay an additional 10% penalty for early withdrawals. Depending on why you are withdrawing retirement money prematurely, you may be exempted from the 10% early withdrawal penalty.

Withdrawing from 401(k) between Age 55 and 59 ½

If you take a distribution before attaining age 59 ½, you could be required to pay income taxes and a penalty on the distribution. However, an exemption to this IRS requirement is when you quit your job at 55. This exemption is known as the rule of 55, and it allows participants to avoid paying the 10% penalty tax when they leave their employer at age 55. This rule does not apply if you are still working for the employer managing your 401(k) account.

You can take a penalty-free distribution if you are laid off, fired, or you resign from your job in the year when you attain age 55. If you quit at age 54 and wait until you are 55 to start taking withdrawals, you will still owe a penalty tax on the withdrawn amount. Additionally, if you rollover your 401(k) to an IRA, the rule of 55 does not apply. You will have to wait until you are 59 ½ to take a penalty-free withdrawal from an IRA.

Withdrawing from 401(k) After Age 59 ½

Once you are 59 ½, you may access your 401(k) money tax-free depending on the following two conditions: 

You are working

If you decide to continue working after attaining age 59 ½, you cannot take a penalty-free distribution from the 401(k) plan of the company you currently work for. Some employers may allow in-service distributions if you are still working for the company, but you should check with the plan administrator to know if this is an option for you. However, if you have old 401(k)s left with former employers, you can start taking penalty-free withdrawals when you turn 59 ½.

You are retired

If you decide to retire when you reach 59 ½, you can take penalty-free distributions from the 401(k) account. If you have multiple 401(k) accounts, you can rollover the 401(k)s into an IRA to consolidate the retirement money. You can continue taking distributions from the IRA without paying any penalties.

Taking Required Minimum Distributions after 72

Once you reach age 72, you must start taking the required minimum distributions (RMD) from the 401(k) account. You must begin taking RMDs by April 1 of the year after your turn 72 (or 70 ½ if you attained 70 ½ before or on January 1, 2020). The amount of distributions depend on your life expectancy.

There is an exemption to the required minimum distributions if you are still in active employment. If you are still working for the employer that manages your 401(k), you may be exempted from taking the mandatory distributions unless you own more than 5% of the company. You cannot qualify for the exemption if you own the company.