Can My Employer Refuse My 401(k) Withdrawal?

If you’re one of the millions of Americans relying on their 401(k) accounts to fund their retirement, it’s essential to know all of the withdrawal rules. This understanding can help you avoid penalties and maximize your retirement savings, setting you up for financial success in the future.

Retirement plans are full of fine print, so we’ll explore some of the subtle details in this article. We’ll focus on the employer’s responsibility in managing 401(k) accounts, various withdrawal options and exceptions, how to access your retirement funds while you’re still employed, the tax implications, and the alternatives to cashing out a 401(k).

Situations When Employers Can Refuse 401(k) Withdrawals

While your 401(k) fund is your money, there are situations when employers can refuse withdrawal requests. Your employer’s plan administrator will outline the details of their retirement account in the summary plan description, but some common scenarios for refusal include the following:

1. If the funds in your account aren’t yet fully vested. These are generally employer contributions that are not yet fully yours, usually because you haven’t met your employer’s minimum years of service requirement. Check your plan’s vesting schedule for more detailed information.
2. Employers may also deny withdrawal requests if they suspect a violation of plan rules or IRS regulations. 401(k) plan rules vary from employer to employer.
3. Withdrawal restrictions may be in place for employees still employed with the company.

401(k) Withdrawal Options and Exceptions

Although many regulations are in place to try to prohibit accountholders from making early withdrawals and to simultaneously encourage them to maximize retirement savings, there are some exceptions.

Typically, all distributions from your 401(k) account before the age of 59.5 will incur penalties, but certain exceptions allow participants to access their funds without penalty.

These include:

1. The Rule of 55 allows individuals who retire at 55 to take penalty-free withdrawals. Note that you must be separated from your most recent employer and at least age 55 years of age for the Rule of 55 to take effect.
2. The age 50 exception (for qualified public safety employees) allows some participants over 50 to withdraw funds without penalty. Note this doesn’t apply to Individual Retirement Accounts (IRAs) of any kind, including Roth IRAs.
3. Becoming disabled may be considered a hardship distribution eligible for a penalty waiver.
4. Significant unreimbursed medical expenses, which can qualify as financial hardship and therefore, may lead to a penalty waiver. “Significant”, in this context, refers to 7.5% or more of your Adjusted Gross Income (AGI).
5. Substantially equal periodic payments (SEPP) are withdrawal plans that allow you to avoid the 10% penalty fee but still require you to pay income taxes on any amounts distributed. SEPP distributions are mandatory for at least five years or until you reach age 59.5, whichever comes later.
6. IRS levy entitles the IRS to seize funds to pay back unpaid tax debt. This also allows the IRS to pursue other property, resulting in situations like a foreclosure on a house or eviction.
7. Qualified reservist distributions happen when military reserve members withdraw from their 401(k)s without penalty if called to active duty.
8. If you die, your 401(k) funds will be passed to your beneficiaries. They can use these funds, penalty-free, to cover funeral expenses and more. Roth 401(k) holders can pass down their funds tax-free.
9. Corrective distributions of excess contributions can be made in a tax year where you accidentally contributed too much and surpassed the contribution limit.
10. You may be able to withdraw some funds for birth or adoption expenses.

Remember, most of these exceptions may relieve the 10% early withdrawal penalty under certain circumstances, but they also may not. However, they will all be subject to income taxes if you’re working with a traditional 401(k).

It’s essential to be aware of the tax implications and consult a financial advisor to ensure you make the best decision for your financial future. In any case, using your 401(k) funds should be seen as a last resort.

Accessing 401(k) Funds While Still Employed

While still employed, you may access your 401(k) funds through hardship withdrawals, in-service withdrawals, or 401(k) loans.

Hardship withdrawals are allowed in certain situations, such as financial hardship due to excess medical expenses or funeral costs. Depending on the situation, a hardship withdrawal may still be subject to penalties, in additional to normal income tax.

In-service withdrawals are typically permitted after a certain age (typically 59 1/2) or under specific circumstances.

• Separately, 401(k) loans aren’t withdrawals, but they are a way to access your 401(k) funds while you’re still employed. 401(k) loans allow you to borrow against your account balance with repayment conditions. There are also potential risks, including reducing your retirement savings, losing out on market gains, increasing your tax burden, and owing interest charges.

Tax Implications of Cashing Out 401(k)

Cashing out your 401(k) before age 59½ usually comes with tax consequences and a 10% early withdrawal penalty. Early withdrawals will be added to your annual gross income, thereby increasing your taxable income and potentially your tax bracket.

Because your contributions were made tax-deferred, you’ll have to pay income taxes when you withdraw money. Plus, you’ll owe an additional penalty fee if you withdraw early.

How can you avoid this? You can wait until retirement age to make penalty-free withdrawals. Or, if you want to move your former employer’s 401(k) to a new account, you can make a direct rollover with no tax penalty or consequence for your tax return in most cases.

Consult a qualified financial advisor before making any decisions.

Options When Leaving a Job

When leaving a job, you have several options regarding your 401(k):

1. Leave the money in the old 401(k) plan: This can have potential advantages, like keeping your funds invested and not having to move them, but also various disadvantages, such as limited investment options or a simple lack of oversight of the account once you move on to a new employer. Remember that employer contributions will stop from your former employer once you leave the company.
2. Move the money to a new 401(k) employer’s plan: This option allows you to consolidate your retirement savings with a new plan sponsor and take advantage of any employer match program in your new job. It will also allow you to have better control over your investments when they are all in one place.
3. Establish a rollover IRA: Rolling your 401(k) to an IRA keeps your retirement funds invested and maintains the account’s tax advantages. Since a traditional IRA is not an employer-sponsored account, you can keep it with you as you change jobs in the future.
4. Cash out and take a distribution: This option has its drawbacks, such as taxes and penalties, and is considered a last resort. But there are instances when it can make sense, like in the event of an emergency.

Alternatives to Cashing Out Your 401(k)

Instead of reaching the last resort and electing a cash out of your 401(k), consider the following alternatives:

1. Maintain an emergency fund: This can cover unexpected expenses without tapping into your retirement savings. A solid lump sum can help you build financial security, although these savings accounts are not beneficiaries of tax-free treatment.
2. Personal loans: If you need funds, personal loans can be a potential alternative to cashing out your 401(k), but they’re still a form of debt and as such will come with an associated interest rate.
3. Home equity lines of credit (HELOCs): This option allows you to access funds using your home’s equity, but you’ll need to be sure you can make on-time payments. This option is also only available to homeowners, of course.
4. Rollovers: Move your funds to a new 401(k) or an IRA without penalty through a direct transfer.

FAQs

Does my employer have to approve my 401(k) withdrawal?

Your employer plays a role in administering 401(k) plans and may need to approve withdrawals in certain situations, such as in-service withdrawals or hardship distributions.

What happens if I withdraw my 401(k) while still employed?

If you withdraw your 401(k) while still employed, you may face taxes and/or penalties, as well as the loss of any tax-deferred growth potential on the amount withdrawn. You’ll be charged federal and state tax on your pre-tax investment withdrawals and may reduce your long-term account balance by missing out on market gains and compound growth.

Can I withdraw my 401(k) while on maternity leave?

Maternity leave is considered an authorized leave of absence. Generally, you cannot withdraw from your 401(k) plan until you have returned to work. However, if your plan has a provision allowing for in-service withdrawals, you may be able to withdraw from your 401(k) while on maternity leave if your 401(k)’s summary plan document permits it.

Need Help Moving Your 401(k)?

Understanding 401(k) withdrawal rules is crucial for making the most of your retirement planning and avoiding penalties wherever possible. Before cashing out a 401(k), explore alternative options and plan for your future.

If you want to roll over your plan, the expert team at Capitalize is here to help you with your retirement accounts.

We make the process streamlined and stress-free so you can start building a financial future. Learn more today.