Taking distributions

You’ve spent much of your working life saving for retirement. Now that you’re about to start drawing on that account or taking distributions, how can you stretch your savings?

 

Here’s what you need to know:

 

Distribution basics

There are many IRS rules governing distributions. These are some key ones:

  • Traditional 401(k) and 403(b) accounts:

    • Distributions are taxable.
    • You may begin taking distributions without penalty once you are age 59½ or because of disability or death.
    • If you leave your company at age 55 or older, you may be able to begin taking penalty-free withdrawals right away.
    • If you take a distribution before age 59½ and do not qualify for an early withdrawal exception, you will have to pay a 10% federal tax penalty.
    • In general, you must start taking annual required minimum distributions (RMDs) no later than April 1 following the end of the calendar year in which you turn 73 or retire, whichever occurs later. The amount of each RMD is based on your account's prior year-end value and the applicable IRA life expectancy factor.
    • If you don’t withdraw the RMD each year, you may be subject to a 25% tax on any amount you should have withdrawn but didn’t.
    • You can always withdraw more than the RMD, but you may want to consider leaving as much of your retirement savings in your account as possible. That way, your remaining savings have the opportunity to continue growing.
    • If you want to avoid RMDs, you can roll some or all of your retirement plan account into a Roth IRA, which is not subject to RMDs over your lifetime. Or if your plan has a Roth option, you can move some or all of your traditional account into a Roth account, which won’t be subject to RMDs over your lifetime for tax years beginning after December 31, 2023. You’ll have to pay taxes on traditional assets moving to Roth, but after that, qualified distributions from Roth assets may be tax-free (see details below).

 

  • Roth 401(k) and 403(b) accounts:

    • Qualified distributions are tax- and penalty-free if the first Roth contribution was made at least five years before; and if the participant is at least 59½ years old, is disabled or has died.
    • For nonqualified distributions, earnings (not contributions) are taxable and may be subject to a 10% early withdrawal penalty.
    • RMDs are required as they are with traditional accounts (see details above).†

† Effective in 2024, participants with Roth 401(k)s or 403(b)s will no longer be required to take lifetime RMDs from those accounts. Distributions from employer Roth accounts will be more in line with traditional (non-employer) Roth IRAs, which do not require withdrawals until after the death of the account owner.

Withdrawal options

 

You have three options, depending on the terms of your plan:

 

  • Move the money into a rollover IRA

    By rolling your retirement savings into an IRA, you can continue to enjoy tax-advantaged growth potential. Roth 401(k) and 403(b) accounts can be rolled into Roth IRAs. Non-Roth accounts can be rolled into traditional IRAs or Roth IRAs. You’ll be responsible for any unpaid taxes on the taxable portion of a Roth IRA rollover. Unlike traditional IRAs, Roth IRAs are not subject to required minimum distributions over the owner’s lifetime.

    With rollover IRAs, you can also:

    • Avoid potential taxes and penalties you might owe if you cashed out.
    • Consolidate multiple retirement accounts.
    • Choose from a potentially wider range of investment options than your employer’s plan offered.
    • Gain greater control over withdrawals than your employer’s plan might offer. (Some employer plans only allow lump-sum distributions; withdrawals from IRAs can be taken over time.)

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  • Leave the money in your plan

    Even if you have retired, you may still be able to keep your money in your retirement plan if the balance is over $5,000 ($7,000 beginning in 2024). Your investments (minus required distributions) will continue to have the opportunity to grow tax-deferred.

    Consider this if you’re happy with your plan’s provider and the choice of investments. Keep in mind that you’ll still be subject to the rules of your former employer’s plan and will need to begin taking minimum distributions after you turn 73.

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  • Cash out with a lump-sum distribution

    Although taking your retirement nest egg all at one time may look attractive, it may bump you into a higher tax bracket.
    That means you may pay a higher percentage of your retirement savings in taxes with a one-time payment than you would if you were taxed over time for smaller distributions. In addition, you lose the potential for your retirement savings to continue growing in value tax-deferred.

    Remember: If you take a distribution, you may have to pay a 10% early withdrawal penalty to the IRS unless you qualify for an exception. In addition, your employer is required to withhold 20% of the distribution for federal income taxes.

    That said, a one-time lump-sum distribution may make sense for retirees who:

    • Have other assets to live on and want to spend their retirement money for a specific purpose
    • Can benefit from special tax treatment for people born before 1936 who can still take advantage of special 10-year forward-averaging and capital gains treatment on lump-sum payments

For more information, see Rollovers.

Tax implications of distributions

Since taxable retirement distributions are considered income, they are subject to prevailing IRS income tax rates. Depending on the type of distribution, federal tax withholding may apply. State withholding requirements can vary as well from state to state.

If you elect to take a bigger distribution than required by law, you may push yourself into a higher tax bracket, with a greater percentage of your distribution being eaten up in taxes.


By taking only the required minimum distribution, you lower your tax exposure and give your retirement savings more time for potential growth.

Qualified distributions from Roth accounts are tax-free and do not increase your taxable income.*

You can invest required minimum distributions taken from your retirement account in a nonretirement account as a way to stretch the financial benefit. However, keep in mind that any income may be taxable.

What you can’t do is roll any income from a required minimum distribution into another IRA or retirement plan.

Here’s a tip: Many retirees leave the work force with savings in both after-tax and tax-deferred accounts. If you have enough income from after-tax accounts and other sources, you may want to save the distributions from your tax-deferred accounts for last.

Talk to your financial professional before making final distribution plans.

 

* Withdrawals from Roth accounts are tax- and penalty-free if the account was established at least five years before, and if the participant is at least 59½ years old, has died or is disabled. For nonqualified distributions, earnings are taxable and may be subject to a 10% early withdrawal penalty.

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