penalty free 401(k) withdrawals

Submitted by Dean Mioli on Fri, 2018-12-21 15:51

Here is the scenario

Client retires at 55 from current employer and can take withdrawals from him 401k without penalty. If he rolls over a previous employer 401(k) plan into his current 401k, can he still take distributions penalty free up to 59 ½?

thanks and happy holidays



Submitted by Alan - IRA critic on Fri, 2018-12-21 16:03

No, not until he separates from the current employer.  The penalty exception only applies to distributions taken from the plan of the employer he has separated from. Therefore, he should not roll the old 401k into the new one until he reaches 59.5 or decides he no longer needs the penalty free distributions.

Submitted by Dean Mioli on Fri, 2018-12-21 16:40

recommended move old 401(k) to IRA, 72t if need be

Submitted by David Mertz on Fri, 2018-12-21 17:09

  • Unless the individual is not permitted to leave the money in the 401(k) due to having a low balance, if the individual needs penalty-free distributions before age 59½, it makes no sense to take a 401(k) eligible for penalty-free distributions and move it to an IRA which would require a 72(t) plan to get penalty-free distributions.  The amount that could be distributed penalty free from the IRA over the next 5 years would be only a fraction of what could be distributed penalty-free from the 401(k), plus there would be substantial risk of busting the 72(t) plan and subjecting all of the distributions to penalty.
  • If the balance is low, the individual cannot leave the money in the 401(k) and the individual needs access to the money before age 59½, it would generally make more sense to take a taxable distribution from the 401(k) and invest the money in a taxable account.  Held more than a year, gains in capital investments in a taxable account would be taxable at long-term capital-gains rates rather than as ordinary income.

Submitted by Alan - IRA critic on Fri, 2018-12-21 17:31

To expand on the limited availability of penalty free 72t distributions, current interest rates generate a 72t distribution of roughly 5% of the IRA balance each year. Conversely, distributions directly from the old 401k would be penalty free, but the plan is allowed to restrict partial distributions in frequency or even to require a lump sum distribution. If the plan will only offer the required lump sum, and if you are more than say 18 months shy of 59.5, taking a lump sum would probably increase your tax rate and the penalty savings could be offset by higher ordinary taxes. Therefore, call your old plan administrator and ask how flexible their partial distribution options are. If flexible enough to live with, then keep the old plan until 59.5. Finally, most 72t plans are implemented for early retirees, not for those still working. It does not make sense to contribute to the new 401k creating an income shortfall when you are pulling money out of the old plan unless the old plan has awful investment options and high expenses.

Submitted by David Mertz on Fri, 2018-12-21 19:12

The only reason I can see to contribute to the new 401(k) while pulling money from the old 401(k) would be to get the company matching contribution in the new 401(k).

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