How to Bypass Mandatory Withholding on a 401(k) Distribution

Article in Summary:

  • The IRS requires plan administrators to withhold 20% from 401k distributions
  • You can bypass the 20% withholding by doing a trustee-to-trustee transfer (rollover) to an IRA
  • IRA’s are not subject to the mandatory 20% withholding

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 (rollover) to an IRA, no withholding is required.  So, as long as you do this correctly, you can effectively take the distribution (after a couple of weeks’ delay) 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.

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.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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  • Jim,

    BTW, I did not have an issue with your colloquialism.

    If I understand your article correctly, I could bypass the mandatory 20% withholding on a $200,000 de-registration of my (prior) employer’s 401(k) for a short-term (i.e., ~30-day) bridge mortgage during the sale/purchase of my primary residence if I did the following:
    a) Prior to needing the funds, complete a direct rollover from the 401(k) to an IRA;
    b) As the date approaches when the funds are required (say a week prior), take a distribution from the IRA which had been funded by the direct rollover (this would trigger the start of the 60-day period within which I need to complete an indirect rollover);
    c) After the purchase of my new home (using these funds) and sale of my old home, ensure that all of the funds distributed from this IRA are reinvested (indirectly rolled-over) in another IRA before the 60 day deadline (from step b)) has been reached.

    Other than ensuring that all of the machinations associated with the accounts and money transfers take place according to required deadlines, do you see any issues with this scenario?

    Thanks, Bob.

    • Not at all, Bob. You could also, in your step c) re-deposit the withdrawal back into the original rollover IRA, saving additional paperwork. It still would meet the once-per-year rollover rule, and would be a tax-free maneuver.

      And thanks for the comment re: colloquialism. Some folks have no sense of humor.

  • Kelly,

    Okay, you’re making my pretty little head swim.

    Quite likely you’re going to have a mess on your hands – since you have a 1099 for income received in 2011, but the 401(k) administrator is also expecting the funds to be returned to the account. If you do nothing, eventually if the 401(k) administrator isn’t aware of the nature of this transaction things are going to get uncomfortable when this all comes to light.

    The administrator will likely classify this as a distribution to you back when the loan was made, I’d guess, and so you’ll get a 1099R for a distribution – which will be taxable (plus penalty if earlier than age 59.5).

    And the more I think about this, the more I wonder why the LLC provided you with a 1099 for this payment…? That’s not normally the case when you pay off a loan, so the 1099 may not be valid.

    I’m not quite sure how it will finally be rectified, but I’d start by letting the 401(k) administrator know what happened. This way (hopefully) the whole thing can be resolved within one or at most two tax years.

    Best of luck to you –


  • I am a member of an LLC (Not a managing member). My 401k has a $150,000 loan to the LLC. They paid off the loan directly to me, so I will report the income on my 2011 tax return. I didn’t report this to my custodian, and I didn’t pay the annual fee for 2012. I will receive a 1099 from them in 2012 with the $150,000. My question is this: I am paying the taxes now for this 2011 direct payment. I won’t show it on my 2012 return. Will I be in trouble with the IRS?

  • Great question Bob – but unfortunately this is not possible.

    The IRS looks at all of your traditional IRAs as a single sum, so that you can satisfy RMD for all by taking the appropriate amount from a single account. However, each 401(k) that you might own is considered separately (and separately from all IRAs) and therefore RMD must be taken from each 401(k) each year.

    Just to make this reply complete – inherited IRAs are also counted individually from your traditional IRAs and must have RMDs taken specifically from each inherited account annually as well.

    Hope this helps!


  • Regarding minimum annual distributions. Can you lump the value of an IRA with the value of a 401K plan to determine the annual minimum distribution and then only take the distribution from a 401k plan account to satify the distribution requirement from an IRA?

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