Why Am I Being Charged Fees to Get My Money Out of My 401(k)?

It happens far too often: workers saving in a retirement plan leave their jobs and decide to take their 401(k) funds with them as a distribution, only to be caught off guard when their distribution is subject to a variety of fees and taxes. The Internal Revenue Service (IRS) will be looking for the income taxes on funds that have been accumulating tax-free, and recordkeepers will be charging a fee for processing the distribution. These taxes and fees apply whether you leave the plan and take your money, or your employer closes the plan and pays you out.

You might also be interested in: How to Locate a 401(k) From a Previous Job

401(k) Distribution fees: Why recordkeepers charge participants

As convenient as it would be, closing a 401(k) account is not the same as closing a bank account. There are many rules and regulations that govern the closure of qualified retirement accounts, so it’s not as simple as pushing a button and sending a 401(k) check. Processing a 401(k) distribution requires compliance with Department of Labor (DOL) and IRS rules, sophisticated software, and highly skilled employees. With so many complex steps involved to properly close a 401(k) account, it’s common for recordkeepers to charge a fee that covers their 401(k) distribution costs.

To put it bluntly, it’s a lot of work for the recordkeeper to process a 401(k) distribution request. There’s a laundry list of what must be done for a typical distribution, including:

Prepare and send out the distribution request and tax notice
Review the distribution request form for accuracy and identify any potential errors
Follow up with the employee and employer for any missing items
Maintain and staff a call center to answer questions from the employee or employer
Verify vesting information
Contact the fund company to begin the process of liquidating the employee’s account
Reconcile the funds that have been received
Perform a final confirmation of all transactions for accuracy
Securely send out the distribution check to the employee
Issue IRS Form 1099-R to report the distribution
Update plan records for the distribution
Track and report the distribution on Form 5500

Learn more: What Happens When You Make an Early 401(k) Withdrawal?

What about the IRS? Glad you asked.

As we mentioned earlier, the IRS will be checking to see if the applicable income tax is paid on a 401(k) distribution. And, if you are under age 59½, there could be an extra 10 percent early distribution tax (however, some exceptions do apply ). Not only that: your distribution will be taxable as ordinary income for local, state, and federal taxes—which means you’ll pay income tax on the money and could potentially be bumped into a higher tax bracket.

Benefits of rolling 401(k) funds over to a new retirement account

The rules and regulations surrounding 401(k) distributions are designed to prevent employees from tapping into their retirement funds early, with the goal of helping protect workers’ financial futures. The regulations remind savers that taking retirement savings as a distribution prior to reaching retirement age should be the last option—a worst case scenario. In fact, the regulations are so strict that you generally can’t even take a distribution from your 401(k) unless one of the following situations applies:

You become disabled, deceased, or otherwise terminate your employment with the company sponsoring the 401(k) plan
Your employer decides to terminate their 401(k) plan

Note: Your 401(k) plan may also allow for in-service distributions while you’re still employed. Check your plan’s Summary Plan Description to determine if your plan allows for these types of distributions. To learn more about the IRS’ general distribution rules, click here.

If you fall into one of the above, you may be wondering what to do with the money in your 401(k). You have three options: roll the funds over to a different retirement account, leave the money where it is until you make a different decision in the future, or take the money as a distribution. It’s important to remember that you’ll likely be hit with some fees for either option—whether you’re leaving the plan or the plan is closing. But what about income taxes?

The best way to keep your 401(k) funds growing without having to pay penalties and taxes is to simply roll the money over into another qualified retirement savings account, like a new employer’s 401(k) plan or even an IRA. There are many benefits of choosing to rollover your 401(k) funds rather than take a distribution if the plan or your account is terminated, such as:

Entire account balance is transferred without tax implications or penalties
401(k) funds are protected from creditors, while personal savings are not
Investments have additional time to grow

Not to mention, keeping your funds in a retirement savings vehicle rather than taking a distribution helps you continue moving forward on the path to retirement readiness—instead of taking a few steps back.

If you have any additional questions about preparing for a financially-secure retirement, we're here to help. Check out our library of Retirement Saving Resources to help set you on the path to retirement readiness.