401k Rules: Follow Them and Avoid Penalty

Oct 6
08:07

2009

Frank Rodriguez

Frank Rodriguez

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When it comes to the workings of your 401k plan there is much to consider. Factors like 401k loans, rollovers and withdrawal all can have positive and negative impacts on your retirement savings. Here's a look at the 401k rules that must be followed in order to avoid penalty.

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What the 401k rules are for withdrawal and rollover come down to mainly what the ages are of the persons who are contemplating withdrawing their 401(k)s or rolling them over into a new IRA or 401k. Knowing these rules can be important when such a time comes, and IRS rules for withholding and withdrawal penalties will apply in many cases,401k Rules: Follow Them and Avoid Penalty Articles so be sure of what the rules are before withdrawing or rolling over.

For someone who is thinking about withdrawing his or her 401(k), there are several options available when the time comes. Most of the rules that are involved in such withdrawals or rollovers are age-based and will depend on a person not working for the previous employer any longer. These age limits and boundaries will apply in almost every case of 401k rules.

Usually, anyone who is less than 59. 5 years of age will operate under slightly different rules than for those between 59. 5 and 70. 5 years old. That particular group can elect to take a lump-sum distribution of the 401k, and a 20% withholding tax will be applied simultaneously. That tax is counted against any income tax payable or refund due for the tax year.

Also, if the 401k amounts to more than $5000 it can be left in the old employer's plan. If it is less than that amount it will be paid out immediately as a lump-sum distribution regardless of the age of the employee. There are also rollover options available, and the amount in the 401k can be placed into an IRA or new 401k plan as long as the employee is opening a single-person business.

Anyone who is less than 59. 5 years of age can make use of the lump-sum distribution, which will also entail the 20% withdrawal tax being withheld and counting against any income tax payable or refund due. Additionally, a 10% early withdrawal penalty is applied, though that does not count against any income tax payable or refund due. It's free money to the government, basically. Check for exemptions to the 10% withdrawal penalty at the IRS website.

Additional 401k rules must also be followed when it comes to 401k loans. Doing some research on 401k loans will give you the proper procedures and cover the positives and negatives.

The same $5000 high or low limits will apply in the case of those who are less than 59. 5 years of age. If more than 5000 it can be left in the care of the old employer's plan and if it's less, it will be paid out in a lump-sum distribution almost immediately. Rollovers of 401k plans into an IRA or new 401k plan for an employee opening a single-person business also apply.

For those who have a 401k and are greater than 70. 5 years old, the rules are slightly different. They can elect to take a lump-sum distribution which will also result in a 20% withdrawal tax being withheld, or it can be left with the old employer's plan. In that case, minimum required distributions will begin very soon after.

Keep in mind that those 70. 5 years of age or older can leave the 401k in the employer plan and do nothing when it but it is taxed at the 50% minimum required distribution rates. The way to avoid that, of course, is to begin taking distributions regularly. If the amount is less than 5000 it will be distributed in a lump-sum. The same IRA or 401k single-person business rules also apply in this instance.