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Just ferinstance, let’s say you need to take a withdrawal from your 401(k) plan – and you’re eligible, either by way of your plan allowing in-plan distributions or the fact that you’re already retired (but you still have the money in your former employer’s 401(k) plan). But here’s the rub: when you take a distribution from a 401(k) plan, the IRS requires that the plan administrator withhold 20% from the distribution. If it’s a significant amount being withheld, it can be a long time before next April when you file your tax return to get the withholding refunded (as long as you’ve covered the tax in some fashion).
Is there are way around this withholding? Of course there is – I wouldn’t tease you like that!
Getting Around the Mandatory Withholding
Cutting to the chase: if you had your money in an IRA and took a distribution, the IRS would not require withholding. But how do you get it to the IRA? Didn’t I just say that the IRS require withholding when you take money out of the 401(k) plan?
Well – not in all cases. If you do a trustee-to-trustee transfer (also knowns as a direct rollover) to an IRA, no withholding is required. So, as long as you do this correctly, you can effectively take the distribution and you don’t have to have any withholding at all. Of course, since you’ll eventually be taxed on the distribution, you probably should have something withheld, but depending on your circumstances, the rate of the withholding may be something far less than 20%. You might even make up the difference (again, depending on the circumstances) by increasing your W4 withholding, or making an estimated tax payment from other sources.
Once you’ve completed the direct rollover to the IRA, you’re free to take a distribution at any time.
Since IRAs are not subject to the mandatory 20% withholding by the IRS, and further since a direct, trustee-to-trustee rollover from a 401(k) plan is also not subject to the mandatory withholding, you can bypass the withholding requirement in the described manner. Just make sure you have a plan to cover the tax on the distribution somehow.
Sterling Raskie, MSFS, CFP®, ChFC®
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And if you’ve come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed “advisor’s advisor”.
Thanks, I’ll keep my eye out for your answer, Elizabeth
I am right now in the process of withdrawing part of a 401K that I was given in a divorce settlement. To adjust the withholding I included IRS form W-4P. It’s still being processed, but it looks like that’s what the firm that handles the plan needed. I actually asked for an additional amount withheld, but line 1 on the form lets you check if you don’t want any withheld at all. Of course, you would need to make your own estimated payment if needed or you’d be in tax trouble. Am I understanding this correctly? Hope so, because I plan to take another chunk next year, so as to lower the total tax hit. Thanks for the column, very timely info!
Hi, Elizabeth –
I don’t know for sure and I’ll research it further, but there may be an exception for QDRO settlements. Hope everything works out for you – and I’ll post any updates here as I verify the facts about situations such as this.