---
title: "Rules and Taxation of 401(k) Plan Distributions"
date: 2017-01-20
author: "Site Admin"
featured_image: "https://pinnacle-plan.com/wp-content/uploads/2017/01/government.avif"
categories:
  - name: "Newsletters"
    url: "/category/newsletters.md"
---

# Rules and Taxation of 401(k) Plan Distributions

[![](http://pinnacle-plan.com/wp-content/uploads/2017/01/government-269x300.png)](http://pinnacle-plan.com/wp-content/uploads/2017/01/government.png)View This Newsletter: [Rules and Taxation of 401(k) Plan Distributions](http://pinnacle-plan.com/wp-content/uploads/2017/01/2017-Benefit-Insights-1-Rules-and-Taxation-of-401k-Plan-Distributions.pdf)

Overview:

A 401(k) plan permits employees to defer a portion of their salaries on a pre-tax basis with the objective of accumulating assets for retirement. Additional assets are accumulated if the employer makes contributions to the participant’s account.

- Rollover vs. Cash Distribution 
    - Distributions from 401(k) plans are generally made in a lump sum, although some plans permit participants to elect installment payments or an annuity.
    - If the distribution is eligible for rollover, the participant can avoid immediate taxation by rolling it over to a traditional IRA (not a Roth IRA) or another qualified plan.
- Mandatory Federal Tax Withholding 
    - If the participant elects to receive a cash distribution and it is eligible to be rolled over, the taxable portion is subject to 20% mandatory income tax withholding (state tax withholding may also apply).
- 10% Premature Distribution Penalty 
    - If the participant is under age 59½, the distribution will generally be subject to a 10% premature distribution penalty unless an exception applies.
- Retirement and Termination 
    - Participants who attain the plan’s normal retirement age become 100% vested in the employer’s account balance and are often eligible to receive a distribution, even if still employed.
- Disability Benefits 
    - Plans may permit distributions due to total and permanent disability.
    - Most plans provide for 100% vesting if the participant becomes disabled.
- Death Benefits 
    - Plans typically provide for 100% vesting upon the death of the participant. The participant’s beneficiary is permitted to roll over the death benefit to an IRA.
- Required Minimum Distributions (RMDs) 
    - The minimum distribution rules require that participants and beneficiaries begin receiving distributions by certain deadlines and limit the period over which benefits can be paid.
    - Here is some more information on [Required Minimum Distributions (RMDs)](http://pinnacle-plan.com/required-minimum-distributions/)
- Hardship Distributions 
    - Many plans permit hardship withdrawals of salary deferrals.
    - The IRS rules regarding hardship withdrawals are very specific and regulations require the satisfaction of two conditions: 
        - There is an immediate and heavy financial need; and
        - Other resources are not available to satisfy the need.
- IRS Special Tax Notice and Reporting 
    - Before making a distribution election, each participant must be given a “Special Tax Notice Regarding Plan Payments” which explains the tax consequences of distributions.
    - Plan distributions are reported to the IRS on Form 1099-R which includes information concerning the type of distribution, taxable amount, taxes withheld and whether or not the 10% penalty is applicable.
- Summary 
    - Employees who do not consider the tax consequences may be in for a rude awakening when they complete their tax returns and discover that not only do they owe additional income taxes on the distributed amount but also a 10% penalty.
    - Plan administrators need to be aware of these complex rules in order to communicate effectively with participants seeking to take distributions from the plan.
- 2017 IRS Annual Limits 
    - Included in the newsletter are the 2017 limits as well as the 2016 limits.
    - Here is more information on the [2017 IRS Annual Limits](http://pinnacle-plan.com/2017-pension-limits/).

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Pinnacle Plan Design is a third-party administrator (TPA) for employer-sponsored qualified retirement plans. We specialize in retirement plan design, administration and actuarial consulting for 401(k)/profit-sharing plans, defined benefit plans, cash balance plans, and 403(b) plans. Pinnacle Plan Design proudly serves businesses nationwide.