In order to avoid taxes and penalties, most of us should wait to access our employer sponsored retirement plan funds until we no longer work for our employer.
It is also common knowledge that for the most part we must wait until after age 59 1/2 in order to access that money without paying early withdrawal penalties.
But in some circumstances your employer sponsored retirement plan may offer the option for employees to withdraw retirement funds while still employed.
One way to do so is via In Service Distributions or In Service Withdrawals.
In service distributions and withdrawals can be useful financial planning tools when deployed correctly.
I recommend seeking the advice of a professional fee only fiduciary financial planner when considering these tools.
We are Fee Only Fiduciary Financial Advisors that specialize in providing comprehensive retirement guidance.
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An in service distribution allows an employee who is still working for their employer to roll over a portion or all of their retirement plan funds into an individual retirement account, or Traditional IRA.
When allowed under the plan rules, and the proper steps are taken, the in service distribution rollover will not incur any tax consequences.
In service withdrawals are a method of accessing retirement funds while still employed by the employer who sponsors your retirement plan.
In service withdrawals are when an employee takes a distribution from a retirement account such as a 401k while still employed.
Different employer sponsored plans may have unique rules around when these type of withdrawals and distributions are allowed.
The most common criteria used include:
If the employee is under age 59 1/2, early withdrawal penalties will be applied to the withdrawal or distribution.
The 5 year participation rule requires that the employee has participated in the plan for at least 5 years before completing their first in service distribution or withdrawal.
The 2 year accumulation rule is a bit trickier to track - this usually requires that funds not be withdrawn until at least two years after the deposit date.
Again it is important to note that different employer plans will have different rules. Later on in this article we will discuss how to research what your specific plan will allow.
The difference between an in service distribution and an in service withdrawal can be unclear and can cause tax consequences when not understood fully.
The in service distribution specifically refers to rolling money from a 401k or other employer sponsored retirement plan into an IRA - meaning you don't touch the money yourself.
That money is being rolled over for the purpose of being invested in an individual retirement account rather than being spent. In service withdrawals are when the funds are actually withdrawn as cash for personal use.
Most employer sponsored retirement accounts are tax deferred investment options.
This means that the growth of the money invested is not taxed until a distribution is taken from the account.
An in service withdrawal - where the funds are withdrawn for personal use - will result in taxes owed.
An in service distribution - where the funds are rolled over into an IRA - does not result in taxes owed because the money never entered the employees possession.
This difference, once understood, makes it clear that in service distributions and in service withdrawals should be used for very different purposes.
In service distributions are mostly used for the purposes of diversification.
As pre-retirees enter the retirement risk zone (the period of time 5-10 years before retirement and 5-10 years following retirement) steps must be taken to protect your wealth.
Diversifying the location and investment selection of your retirement assets are two ways to do that.
Spreading your wealth among multiple retirement accounts or multiple custodians protects you should your employer run into financial trouble or possibly go out of business.
And because 401k and 401k type plans offer very limited investment options, having a certain percentage of your money in a traditional IRA or comparable account will allow for greater investment variety.
Normally withdrawals from an employer sponsored plan prior to 59 1/2 will incur a 10% penalty.
The following exceptions provided by the internal revenue service allow for hardship distributions prior to 59 1/2 (although the withdrawable amount will be limited):
Certain types of contributions to your 401k type plan can be distributed after age 59 1/2 without needing to meet the hardship distribution requirements.
As explained above, these contributions can be distributed for personal use while still employed.
If you have financial need or want to invest in investments outside of your employer sponsored plan, non hardship withdrawals may be a solution.
Just remember that even non hardship withdrawal funds for personal use will result in tax being owed.
Your employer sponsored plan administrator has reason to keep employees from removing money from their accounts early.
The plan administrators typically get paid on the total dollar amount within the plan and therefore want to keep funds in the plan.
For these reasons it can be difficult to find out your plans in service distribution and in service withdrawal options.
Finding that information will oftentimes require some online research AND making a call to your plan help line.
The best place to begin is with a quick search of your online retirement account dashboard.
If you are able to find a plan document in the file vault called the "Summary Plan Description" you can do a quick search using your computers search function for the following terms:
Or other variations on those phrases.
If those methods fail, you can call your plan provider and ask them what your options are.
You can ask the following questions:
Once you've identified that your plan will allow in service non hardship distributions and withdrawals, you'll want to consult with a professional financial advisor of tax professional.
As mentioned above, these activities can cause tax liabilities that must be planned for.
If you're looking for advice regarding your retirement plan, please watch our free masterclass training video detailing the top strategy pre retirees are using to optimize their retirement strategies.
Or you can visit our contact us page to get in touch.
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