What Is a Redeposit?

A redeposit, in reference to a qualified retirement account, is a required repayment by an employee of any money withdrawn early from a retirement fund to avoid penalties. The redeposit is made to ensure that the person's retirement funds will be available in the amount expected or to avoid a tax penalty on an early withdrawal. This repayment is referred to as a redeposit service.

The word redeposit also has a more general meaning of any sum of money or check withdrawn and then deposited again in a bank, or any substance that is removed and then restored to its original place.

Key Takeaways

  • A redeposit is a provision that allows retirement money to be withdrawn from an IRA and re-invested within 60 days to avoid IRS penalty.
  • Money may also be 'borrowed' from a 401(k) and redeposited within five years to avoid a penalty.
  • In any case, the rules for redeposits should be read carefully to avoid a big tax bill.

Understanding Redeposits

Depending on the type of retirement account and on the company's policies, employees may be able to take loans against the balances in their accounts. The right to withdraw funds is often limited to certain purposes, notably a first-time home purchase or college education costs.

The balance available for withdrawal is usually limited to the employee's contributions to the fund, not to any company matching contributions. The number of withdrawals may be limited as well. In any case, the money withdrawn may be considered a loan, although the money is loaned by and to the same person.

Rules for IRAs and 401K Accounts

The two best-known types of retirement accounts have very different rules. In both cases, the IRS sets the rules and imposes a 10% tax penalty on the amount withdrawn if the account owner breaks them.

  • Individual Retirement Account withdrawals must be redeposited within 60 days, or the account holder will owe income taxes on the amount withdrawn and a 10% penalty for early withdrawal.
  • 401(k) company-sponsored plan withdrawals must be redeposited within five years or the income taxes, and the 10% penalty are owed.

Exceptions to the Rules

Getting money out of a retirement account isn't easy, and it's not supposed to be. The money is supposed to sit there and grow until the employee reaches age 59 1/2. If that rule is broken, the employee must pay a 10% penalty tax.

A timely redeposit to a retirement account is necessary to avoid IRS penalties.

At that point, the employee can begin making withdrawals. If it's a traditional IRA, the money is taxable, and the account holder must start taking distributions by age 70 1/2. If it is a Roth IRA, all taxes due were taken when the money was deposited, and no taxes are owed later when the money is withdrawn.

However, there are a number of exceptional circumstances in which an employee can make an earlier withdrawal. Note that in the case of 401(k) accounts or other company-sponsored retirement accounts, the company may have its own rules, too, regarding whether and in what circumstances an employee may make withdrawals from the account.

The IRS exceptions include:

  • Withdrawals to pay medical costs that exceed 10% of the account holder's adjusted gross income will not be subject to the 10% penalty (although the income taxes will still be owed).
  • Withdrawals that are used to pay for medical insurance, college costs, or a first-home purchase, are eligible for a penalty exemption.

The IRS rules are, as always, complicated and should be read thoroughly.

The Roth Exception

It is generally easier to get money early from a Roth IRA or 401(k). A Roth account requires the investor to pay the money upfront at the time it is deposited, and no additional taxes are due when they are withdrawn after retirement.

In general, a Roth account holder can withdraw money early without penalty.