What Are Withdrawal Benefits?
Withdrawal benefits refer to the rights of employees with pension or other retirement plans to cash out any accumulated funds upon leaving an employer.
Withdrawal benefits apply most often to defined contribution plans, under which employers and employees each contribute either a fixed amount or a percentage of each employee’s paycheck, to a plan such as a 401(k). The majority of companies with defined contribution plans match what employees save for retirement at a fixed ratio, up to a certain salary percentage, such as when an employer matches 50 cents on the dollar, up to 6 percent of each individual’s salary.
Occasionally, withdrawal benefits apply to a defined benefit, or traditional pension plan. But in most cases, any earned benefits from these plans remain locked up until employees become eligible to receive them, typically at age 65.
The value of withdrawal benefits depends on an individual employee's salary or pay scale, years of service, and possibly other factors. It also varies based on whether the employee is vested. Some companies and unions use cliff vesting, where all benefits, including company matches, kick in after a certain number of years, while others offer graded vesting, under which benefits accrue over time.
How Withdrawal Benefits Work
Withdrawal benefits come into play most often for employees who are leaving the type of midsize-to-large employers that tend to offer 401(k)s. Vested employees often receive a check for any withdrawal benefits; for tenured employees, this may be the largest check they have ever received in their lives.
Under a set of specific circumstances, employees who are not of retirement age can roll over, or transfer, this check to a new employer's 401(k), or to an Individual Retirement Account (IRA) for a set period without incurring tax liabilities or penalties.
Note that most employer- and union-sponsored retirement plans in private industry in the U.S. fall under the Employee Retirement Income Security Act of 1974 (ERISA) and the internal Revenue Code.
Basic Rules Related to Withdrawal Benefits
Reinvesting withdrawal benefits without a penalty is fairly straightforward, provided employees follow the rules. Any check needs to go into either a qualifying IRA or retirement plan within 60 days, otherwise the employee must pay tax on it. This means employees much check with their new employers to be sure the new plan is qualifying.
Receiving withdrawal benefits either requires employees to fill out forms or answer a series of questions online or over the phone. Withdrawal benefits often take a week or more to process.
Employees age 55 or over receiving withdrawal benefits from a 401(k) may be allowed to take a lump-sum distribution from a defined-contribution plan without paying a penalty for early withdrawal. The same general idea applies for IRAs, although the minimum age is 59½. In either case, employees still owe ordinary income taxes.