Who can withdraw from 401k?

If you have accumulated a substantial nest egg, you are allowed to start taking distributions from 401(k). However, if you are below 59 ½ and you have a financial emergency like medical expense or eviction notice, you can still withdraw money from your 401(k) early. 

Apart from the 401(k) owner, several other parties can withdraw from 401(k). Once the 401(k) owner passes away, designated beneficiaries will inherit the retirement assets left by the deceased 401(k) owner. In a divorce settlement, the court may grant an ex-spouse a share of their former spouse’s 401(k) assets. The IRS can also levy a 401(k) to recover amounts owed in back taxes.

Parties who can withdraw from 401(k)

Here are the various parties who can withdraw money from a 401(k):

401(k) account holder

As the 401(k) account holder, you can access your contributions and earnings at any time during your working years or after retirement. However, there are different rules that determine when a 401(k) owner can withdraw funds from 401(k).

If you are younger than 59 ½, any withdrawals you take from the 401(k) will be considered a taxable income, and you will owe income taxes in the year you took the distribution. You will also owe a 10% penalty for early distribution.

However, there are certain withdrawals before age 59 ½ that may be exempted from the 10% penalty. For example, you can take penalty-free distributions if you become permanently disabled, to pay unreimbursed medical expenses, or if you take a distribution as substantially equal periodic payments.

Once you’ve attained age 59 ½, you can withdraw funds from the 401(k) penalty-free. You will still owe ordinary income taxes on the distributions you take. If you don’t have an urgent need, you can delay taking the required minimum distributions (RMDs) until you reach age 72. You must start taking the RMDs from age 72.

Beneficiaries of 401k

Once a 401(k) owner dies, the retirement savings in the 401(k) account are passed on to the designated beneficiaries. The primary beneficiary, who is often the spouse of the deceased 401(k) owner, inherits the 401(k) assets. However, if the spouse has passed on or disclaims the inheritance, the retirement assets go to the contingent beneficiaries like children, grandchildren, brothers, sisters, parents, friends, etc.

Beneficiaries have various options with the inherited assets. If you are a spousal beneficiary, you can choose to rollover the inherited assets to your IRA, take a lump-sum distribution, or spread distributions over your lifetime.

If you inherit a 401(k) from a parent, you have fewer options with the inherited assets than a spousal beneficiary. The 10-year rule requires that you must take the full distribution by the 10th anniversary of the 401(k) owner’s death. Unlike spousal beneficiaries, non-spouse beneficiaries do not have the option to spread distributions over their lifetime.

Ex-Spouse

A 401(k) is considered marital property, and it may be included as part of the divorce settlement. Once the court determines the marital assets accumulated during the marriage, it will issue an order to divide the assets. The spouses are required to draft a Qualified Domestic Relations Order (QDRO), directing the 401(k) plan administrator to distribute the retirement assets to the spouses.

The QDRO is used to transfer part of the 401(k) benefits to an ex-spouse, either to their 401(k) or IRA. The ex-spouse will retain the tax-deferred status of the distributions. The spouse can choose to rollover the benefits directly to their retirement account to avoid incurring taxes. The QDRO exempts the spouse from paying an early withdrawal penalty on the money even if the distributions are made before age 59 ½. 

IRS to settle IRS levy

Although your 401(k) is protected from garnishment by creditors, the IRS can still place a levy on your 401(k) for back taxes. If you owe back taxes to the IRS, the IRS will issue a notice, informing you of its intent to levy your 401(k). This notice gives you some time to pay the back taxes using other income sources if you want to keep the 401(k) intact.

If you don’t pay the taxes owed within the notice period, the IRS will levy your 401(k) as long as 401(k) withdrawals are not restricted due to age or other reasons. Any distributions used to settle the levy are exempted from the 10% early withdrawal penalty. However, you will owe ordinary income tax on the distribution.

If you are below 59 ½ or you are still working for your employer, the IRS cannot levy your 401(k). Instead, it will have to look for other income sources that it can use to recover the back taxes you owe.

Can you take hardship withdrawals from 401(k)?

If you have an immediate financial need and you don’t have the money to pay for it, you may consider taking a hardship withdrawal from the 401(k). 401(k)s are set to allow withdrawals starting age 59 ½, and any distributions taken before this age attract a 10% penalty and ordinary income taxes. However, some expenses may qualify for an exemption from the 10% penalty for early distribution. 

Some of the expenses that qualify for a 401(k) hardship withdrawal include unreimbursed medical expenses, funeral costs, costs related to the purchase of a principal residence, education expenses, or home repairs after a natural disaster.

Before taking a hardship withdrawal, you should check if your employer allows hardship withdrawals. Some employers may require employees to exhaust 401(k) loans and non-hardship in-service withdrawals before taking an early 401(k) withdrawal.