How Does a 401(k) Distribute Retirement Funds?
A 401(k) plan is an employer sponsored plan that allows an employee to save pretax dollars towards retirement. Employees have the option of maintaining a 401(k) plan with the employer, even after they leave the company. Retirement plan administrators must adhere to certain rules and regulations when distributing retirement funds.
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Distribution Requests
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A 401(k) plan is required to distribute funds upon request by the employee. Employees must fill out a distribution request that designates how much should be liquidated from which investments and where the distribution should be sent. Distributions can be sent to the employee via a check or through a direct deposit into a bank account. In some instances when an employee must take a mandatory distribution, such as when he reaches age 70 1/2, the employee may request an "in kind" distribution, which removes a specified amount of a security and places it in a nonqualified account to satisfy the distribution while reducing tax consequences down the road if the security continues to appreciate.
Withholding Issues
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When taking assets out of the 401(k), the option of withholding comes up in the paperwork. Withholding results from an assumption by your 401(k) administrator and the IRS that you are spending the money. Indirect rollovers (where a check comes to you) require a 20 percent withholding at the time of distribution, even though you are rolling the assets into another fund. After the completed rollover, you must then add funds to the account equal to the withholding amount and get the withholding back in your tax return. Direct rollovers (custodian to custodian) do not have this withholding issue. Regarding regular taxable distributions at the state level, you can request to have more or less than the standard 20 percent withholding. Remember to report the income on your tax return. Distributions generate a 1099R or 1099I form at the end of each year to account for the distributions to the IRS.
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Rollover Details
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A 401(k) to IRA rollover is a very common transaction in the investment world. This happens when an employee leaves a company and wants to place the funds in an account where she has more control over the investment options. When this type of distribution happens, the 401(k) administrator may conduct a direct rollover, sending a check directly to the new custodian. The other option is conducting an indirect rollover, wherein the custodian sends the rollover check to the employee, who has 60 days to deposit the money in the rollover IRA.
Optional Distributions
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A 401(k) plan has the option to offer bells and whistles that the IRS allows in employer sponsored retirement plans. The bells and whistles include hardship distributions to help an employee prevent eviction or foreclosure. The IRS permits employees who have medical bills in excess of 7.5 percent of annual income to take unpenalized distributions to pay for these expenses. A plan also has the option to allow loans against the assets. A person can borrow up to 50 percent of his vested 401(k) balance as long as he repays the money within five years through regular paycheck deductions.
Considerations
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It is important to consider that not all the money you see on an IRA statement is automatically your own. Employers may match employee contributions or they may give nonelective contributions to all employees. These contributions come with the requirement that the employee will work at the company for so many years before the money is completely his, or vested. An employer may create a sliding scale to determine the vesting percentages based on years of employment. If the employee leaves before the vesting schedule is completed, he only receives his contributions, earnings on his contributions and the amount he has vested.
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