Withholding Requirements for 401(k) Plan Distributions

Distributions of a participant’s vested balance in their 401(k) plan are allowed under the following circumstances:

When a participant requests a distribution, a determination must be made on whether or not federal income taxes are required to be withheld from the distribution, and if required, how much should be withheld. Distributions of pre-tax employee deferrals and employer contributions from a 401(k) plan are subject to federal income taxes unless the distributions are rolled over into another qualified retirement plan or traditional IRA within 60 days of the date of the distribution. Normally, any taxable distribution is subject to a mandatory federal income tax withholding of 20%. However, there are certain circumstances when a participant can choose not to have the 20% federal income tax withholding from their distribution. These circumstances include the following:

Periodic payments are pension or annuity payments made for more than 1 year that are not eligible for rollover distributions, and are substantially equal payments made at least once a year over the life of the participant and /or beneficiary or for a minimum of 10 years. For withholding purposes, these payments are treated as if they are wages and the amount of the withholding can be determined by using the recipient’s completed Form W-4P, Withholding Certificate for Pension or Annuity Payments, and the income tax withholding tables and methods in Publication 15, Circular E, Employer’s Tax Guide.

A nonperodic payment is a payment other than a periodic payment. If the nonperiodic payment is not an eligible rollover distribution (discussed below), then it is subject to a 10% federal withholding. However, the participant may request no withholding from this distribution or may request an additional amount to be withheld using Form W-4P.

A nonresident alien can elect exemption from withholding only if he or she certifies that he or she is not a U.S. citizen or resident alien, or an individual to whom IRS Code section 877 applies (concerning expatriation to avoid tax). If a nonresident alien chooses this exemption, then the withholdings are determined using Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.

Distributions that are eligible for rollover are subject to a 20% federal withholding, unless the distribution is paid as a direct rollover to a qualified retirement plan or traditional IRA. There should be no withholdings from distributions that are paid as a direct rollover. For eligible rollover distributions that are not paid as a direct rollover, participants can request a withholding amount that is greater than 20%.

All distributions from a 401k plan are considered eligible rollover distributions, except for the following types of distributions:

It should be noted that each state has its own rules regarding income tax withholdings of 401(k) plan distributions. In addition, some states have mandatory income withholding requirements, while other states allow participants to voluntarily withhold income taxes and there are some states that do not impose a state income tax on 401(k) distributions.

The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriately qualified professionals for your plan’s individual facts and circumstances.