Can a Trustee Refuse Your 401(k) Withdrawal?

If you belong to a 401(k) plan at work, it’s helpful to understand how the plan works, especially with regard to your rights to withdraw money from it. A 401(k) is a qualified, defined contribution plan, meaning it provides important tax advantages and the benefits it pays out depend on the contributions you and employer make. To protect the integrity of the plan, the plan sponsor (your employer) places the plan in a trust and appoints a trustee as administrator. The trustee can indeed refuse a 401(k) distribution request if the plan doesn’t allow it.

You can only withdraw money from a 401(k) if you are a participant and have a vested balance. Your employer must allow you to participate in the 401(k) plan it offers if you are 21 years or older. The plan might require you to be employed for up to one year before you’re allowed to participate. Vesting is a process in which your account balance becomes nonforfeitable over time. If you separate from your employer, you forfeit the non-vested portion of your account balance. You cannot withdraw non-vested money from your 401(k). Your contributions to your 401(k) are always immediately vested, but employer contributions to your account may be subject to a vesting schedule.

You are eligible for qualified reservist distribution, which applies to military reservists and National Guard members who have been on active duty for at least 180 days or for an unspecified, indefinite period.

In general, an event must occur before your can withdraw money from your 401(k), and the plan trustee can refuse your withdrawal request in the absence of one of these events. The 401(k) withdrawal rules name these eligible events:

• You die, become disables, retire or otherwise separate from your employer.
  
• The 401(k) plan terminates, and no successor plan is offered.
• You reach age 59 ½.
• You suffer a financial hardship (but subject to the plan rules).
• You are eligible for qualified reservist distribution, which applies to military reservists and National Guard members who have been on active duty for at least 180 days or for an unspecified, indefinite period. 
  

Distributions from a traditional 401(k) plan must be included in your taxable income for the year. If you are below age 59 ½, 401(k) distribution rules might require a 10-percent penalty tax for early withdrawals unless you qualify for an exception. For example, qualified reservist distributions are exempt from the penalty tax.

You can specify a distribution to be a lump sum, or you can set up a series of periodic distributions based on your life expectancy as determined by the IRS.

You or your beneficiary do not have to pay the10 percent early withdrawal tax on distributions made for the following reasons:

• You die.
  
• You become disabled.
  
• A required minimum distribution, which applies when you reach age 70 ½.
  
• Severance from your job after reaching age 55.
  
• High medical debt.
  
• A series of substantially equal payments made at least annually and lasting for your life expectancy, you and your beneficiary’s joint life expectancy, or a period of 10 years.
  
• A return of nondeductible contributions to the 401(k) plan.
  
• Loans that are recategorized as distributions.
  
• Dividends you receive from your employer’s stock.
  
• The cost of a life insurance policy held in the plan.
  
• Return of excess contributions.
  
• Distributions arising from a Qualified Domestic Relations Order made to someone other than a spouse or ex-spouse.
  
• Timely withdrawal of automatic enrollment contributions.
  

This list indicates which types of withdrawals are penalty-exempt, but the trustee doesn’t necessarily have to approve withdrawal requests based on all of the list entries.

The written 401(k) plan documents declare whether the plan permits hardship distributions. Naturally, the plan trustee will refuse your request for a hardship distribution if the plan doesn’t permit it. However, many plans that offer employee elective contributions also permit hardship distributions, and the plan must specify criteria to determine that a hardship withdrawal is allowed. In this regard, the criteria can be highly specific and arbitrary. For example, the plan might allow hardship withdrawals to pay for medical or funeral costs, but not for tuition or home purchase. Whatever the criteria, the plan trustee must apply them using objective and nondiscriminatory standards.

To qualify, a hardship must arise from a heavy, immediate financial need of the employee, spouse or dependent, and the withdrawal amount cannot exceed what is necessary to satisfy the financial need. Generally, the hardship withdrawal will only be approved if the employee has exhausted all other sources of funds, including a loan from the 401(k) and the assets of a spouse and minor children (except assets held in an irrevocable trust under the Uniform Gifts to Minors Act).

The rules specify a set of “safe harbor” expenses that automatically qualify as financial hardships. That is, your plan trustee can rely on these reasons to safely justify a hardship distribution, as long as the plan allows it. The safe harbor expenses are:

1. Medical expenses that exceed a certain threshold.
   
2. Costs stemming from the purchase or construction of a primary residence.
   
3. Certain educational expenses including tuition and fees.
   
4. Payments required to avoid eviction from your primary residence.
   
5. Funeral or burial costs.
   
6. Certain expenses arising from the need to repair your primary residence after damage.
   

Note that, of these six safe harbor reasons, only distributions for high medical costs are exempt from the 10 percent early withdrawal penalty. If your hardship stems from any other reason, you will have to pay the10 percent early withdrawal tax. Upon receiving a hardship distribution, you are banned from making further contributions to the plan for a period of six months.

The maximum you can withdraw cannot exceed your total elective contributions and excludes certain employer contributions as well as any earnings your contributions generated. Hardship withdrawals permanently reduce your 401(k) account balance and cannot be rolled over into another retirement plan or IRA.

A 401(k) may include a Roth account that accepts post-tax contributions, that is, money on which you’ve already paid taxes. The distribution rules that the trustee follows for a traditional 401(k) also apply to the Roth account, with certain exceptions:

1. Distribution of contributions is tax- and penalty-free.
   
2. Distribution of earnings during the first five years following the initial contribution are subject to tax and the 10 percent penalty.
   
3. Distribution of earnings before age 59 ½ are subject to taxes and might be hit with the 10 percent penalty unless an exception applies, such as disability.
   
4. You must start taking required minimum distributions from the Roth account at age 70 ½. Note that this differs from Roth IRA rules, in which required minimum distributions do not apply.
   

If your trustee turns down your withdrawal request, you might want to consider rolling over part or all of the 401(k) balance into an IRA, where withdrawals do not require your trustee’s permission. You can do a trust-to-trust transfer from the 401(k) to your traditional IRA without triggering taxes, penalties, withholding, or the 60-day deadline that applies to rollovers of distributions. If your rollover is to a Roth IRA, you must include any pretax money in your current ordinary income. However, you generally will pay no tax or penalty when you roll over a 401(k) Roth account to a Roth IRA, since you’ve already paid taxes on this money.