401k laws, 401k loansIt seems like we have laws for everything now-a-days. There are laws for unemployment, health care, workers comp, overtime pay and workplace safety.   So why wouldn’t there are also be laws that govern 401k’s….there are…lots of them.

401k’s are highly regulated.   401k laws are regulated by the federal government, not the state or local governments.

The purpose of 401k law is protection.   401k laws protect both employees and employers.   Both sides are protected because the laws clearly state the rules and regulations each side must follow or face fines and penalties.  As a 401k employee, you want to know your 401k laws; knowledge is power.   Let’s review them for you.

401k Laws:

Laws about 401k loans:

Loans on 401ks are allowed by law.   Employers are not required to offer the 401k loan option.   Loans are required to be paid back within 5 years, under some circumstances this can be extended.

  • If 401k loans are not repaid, the IRS considers it a withdrawal.
  • If you are under age 59 1/2, an unpaid loan is an early withdrawal.
  • Early 401k withdrawals are taxed.
  • Early 401k withdrawals incur a 10% penalty.
  • If you are over 59 1/2 at the time you took the loan out, you do not have to repay the loan.
  • 401k loans that you repay are not taxed nor do they incur the 10% penalty.

Laws about 401k distributions or withdrawals:

401k distribution or withdrawal laws deal with taxation and penalties.   401k distributions  and rollovers are taxed differently at different ages.

  • Taxes on distributions or withdrawals.
  • If you are under age 59 1/2, you cannot take a 401k distribution without being taxed and incurring a 10% penalty.
  • Taxes on roll overs.
  • If you are under age 59 1/2 and take a payment from your 401k plan without rolling it over to another 401k or IRA account,  the IRS considers it a withdrawal.
  • If you do not rollover the money to a qualified plan, you will be taxed and get hit with a 10% penalty.

Cashing out 401k rules:

Cashing out 401k rules apply if the money is not rolled over.  Cashing out can get expensive.   If you cash out of your 401k plan, you will be taxed and incur a 10% penalty.

  • You have other options besides cashing out or taking possession of the money.
  • You can leave it in your former employer’s plan.
  • You will not be taxed or penalized if you leave it as is.
  • You can roll it over to an IRA.
  • You will not be taxed or penalized if it gets rolled into an IRA.
  • You can roll it over to your new employer’s 401k plan.
  • You again avoid taxes and penalties when it gets rolled into a 401k plan.

There are so many 401k laws & rules; which is why it can be a bit overwhelming.   If you know the laws and rules, you can work within the system of laws.   You can use the laws to your advantage if you know what they are.

If you are still unclear,  ask your accountant or financial adviser for clarification.