Distribution Options: Taking Money from Your Retirement Plan
When it comes to retirement planning, how much you save and how you invest that money during your working years are important parts of the process. But there’s another factor that, over the long term, can be just as important: It’s the distribution method(s) you choose1 when you take money from your retirement account. The decision you make can have a great impact on the kind of lifestyle you’ll be able to enjoy in your retirement.
When Distributions Can Occur
A retirement plan distribution is typically available to plan participants who are:
- No longer employed by the organization providing the benefit
- Eligible to take a hardship withdrawal or another type of withdrawal, if available
(This article focuses on retirement-related distributions.)
Timing Considerations for Initiating Distributions
- Generally, individuals initially become eligible to take a distribution from their retirement plan when they reach age 59½—whether or not they are still working.1 (There is no requirement, however, for participants to begin receiving distributions at this time.)
- Those who stop working and take one or more distributions before age 59½ will have their payouts treated as early withdrawals by the IRS, and may be subject to a 10% early withdrawal penalty2 in addition to income tax.
Distribution Rules for Retirees
Under the terms of your defined contribution plan (i.e., your 401(k), 403(b), or governmental 457(b) plan), you are required by law to begin taking distributions from your account by April 1 following the year in which you reach age 70½, or when you retire, if later—and every year thereafter as long as you have money in the account. (These are what are commonly referred to as “required minimum distributions” or RMDs.) In any year in which you fail to take your required minimum distribution, you’ll risk incurring a 50% penalty on the RMD amount from the IRS.3 To help you determine the amount of your RMD, use the Required Minimum Distribution (RMD) Calculator.
Distribution Options at Retirement
Generally, defined contribution plans offer various ways for retiring participants to take distributions. These may include:
- Keeping the money in your current retirement plan and withdrawing funds as you like
- Purchasing an annuity
- Taking a lump-sum cash distribution
- Taking a rollover distribution
Each of these distribution options is outlined in the table below—along with some of the advantages, disadvantages and special considerations.
To find out which options are available through your plan, as well as the specific rules pertaining to your plan’s distributions, contact Prudential Retirement® or your plan administrator.
How It Works1
Keep the money in your current retirement plan and withdraw funds as you like
Generally, you may either:
- Withdraw money as you wish until your funds are gone; or
- Receive regularly scheduled payments for as long as your account balance allows.
While you are receiving distributions, your unpaid retirement account balance remains invested in the plan investments you have chosen.1
- Generally, you’ll need to have a minimum amount (e.g., $5,000) in your retirement account1 in order to qualify for this option.
- If your retirement account has lost value due to unfavorable investment performance, you are giving the money remaining in your account the potential to recoup those losses.
- You’ll avoid current taxes on the amount that remains in your account (until you receive it).
- Your investment choices may be more limited once your distributions begin1—and you may not have complete control over your money if you’re receiving regularly scheduled payments.
Use part or all of your account balance to purchase an annuity
An annuity is essentially an insurance product that guarantees a series of regular (usually monthly) payments. The amount of your payment will depend on:
- the type of annuity you've selected;
- your age (for a lifetime annuity);
- the amount you invested in your annuity—and the interest rate for that money; and
- any fees and expenses that apply to your annuity.
- This may be a good option for those who are concerned about outliving their income.
- You’ll receive a predetermined amount of income during your annuity’s payment period.
- You are only taxed on your annuity payments as you receive them.
- Annuities are longer-term products and may not be appropriate for everyone.
- Annuities have fees and expenses.
- Once you’ve purchased your annuity, you have no say over how the amount that you’ve paid for your annuity will be invested—essentially, you’ve given up control of that money in exchange for your annuity payments.
- Your distribution option decision is irreversible once your annuity has been purchased.
Take a lump-sum distribution
You’ll receive a one-time payment of your entire retirement account balance. Your distribution will include:
- all of your own contributions;
- the investment earnings on your contributions; and
- your vested4 portion of any employer contributions—and the investment earnings attributable to those contributions.
- Designed as an option for those who need or want immediate access to their retirement account assets.
- If your retirement account has lost value due to unfavorable investment performance, you will be “locking in” your losses with this option.
- You will be subject to income taxes on the total amount of the distribution. This may mean you’ll pay much more in taxes on your distribution (when compared to the other distribution options)—since your distribution may put you in a higher tax bracket for the year. Your employer or plan sponsor will be required to withhold 20% of the taxable amount for federal income taxes so you will only receive 80% of your balance up front. You may also be subject to state income taxes (depending on the state you live in).
- After you have paid the taxes on your distribution, you can spend or invest your money as you wish.
Take a rollover distribution
You’ll transfer part or all of your retirement account balance to another tax-deferred retirement account.
- This may be a good option for those who want all of their retirement account assets to be in a single account.
- You may have access to more investment options through your new retirement account.
- If your retirement account money is rolled over directly from your existing retirement provider to your new account provider, 20% withholding will not be deducted from your rollover funds.
- If you roll your money over to an IRA, your new account may have higher fees (than your existing employer-sponsored account). The penalty exception for separation from service after age 55 will
no longer be available once the funds are rolled to an IRA.
- If you have funds invested in employer
stocks, you lose the favorable tax
treatment for net unrealized appreciation (NUA) once rolled to an IRA.
Before You Make Your Distribution Decision…
Only you can decide how you want to receive the money in your retirement account. When weighing your plan’s distribution options, you may wish to consider the following:
- How do you want to use your retirement account assets: Do you want to draw retirement income for the rest of your life—or leave some of your retirement money for your heirs?
- People are living longer, so there’s a good chance you’ll be retired for 20 to 25 years—or more.
- If you’ll need retirement income for your lifetime, consider using a sustainable withdrawal schedule, or you’ll risk outliving your savings. As a general guideline, many financial professionals advise that annual retirement account withdrawals not exceed more than 4% or 5% of an individual’s nest egg.
You don’t have to go it alone!
When it’s time to take money from your retirement account, you’ll have several choices and a lot to consider. However, help is available. A financial professional or a Certified Prudential Retirement® Counselor* can help you consider your options based on your personal situation, and walk you through the steps needed to initiate your distribution method. To reach a Prudential Retirement Counselor, simply call 1-877-PRU-2100 toll free, Monday through Friday, from 8 a.m. to 6 p.m., ET.
* Many of Prudential Retirement’s Personal Retirement Services Retirement Counselors carry the distinct designation of Certified Retirement Consultants, an advanced certification available through the International Foundation for Retirement Education (InFRE). Certification includes mastery of retirement plan design, investment strategy, retirement income management, and retirement readiness and counseling.
Retirement Counselors may receive compensation based on a decision to either keep your funds in your employer-sponsored retirement plan or roll over to a Prudential IRA. These representatives receive additional compensation based on whether and how much you roll over to an IRA, and their compensation recognizes the additional services involved in the rollover process. Such compensation does not differ based on which Prudential IRA you choose or how your money is invested.
1 Subject to plan provisions.
2 Governmental 457 plan withdrawals are not subject to the 10% premature distribution penalty. Separation from service after age 55 is one exception to the penalty. Others may also apply.
3 The penalty for not taking a required minimum distribution is 50% of the minimum distribution amount that you should have withdrawn.
4 “Vesting” refers to that portion of your employer’s contributions that you own. Based on your plan provisions, you may be vested for all or only a portion of your employer’s contributions. Contact Prudential Retirement or your plan administrator for more information.