In Service Distributions and Withdrawals
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.
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What is an In Service Distribution?
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.
What is an In Service Withdrawal?
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.
When are In Service Distributions & In Service Withdrawals Allowed?
Different employer sponsored plans may have unique rules around when these type of withdrawals and distributions are allowed.
The most common criteria used include:
Attaining age 59 1/2
Having 5 years of participation in the employer sponsored plan
Having 2 years of accumulation
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The 2 year accumulation rule is a bit trickier to track - this usually requires that funds not be withdrawn until at least two years after the deposit date.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.
Getting Clear on the Difference Between In Service Withdrawals and In Service Distributions
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.
What is the difference tax wise between the two?
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.
Why Perform an In Service Distribution?
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.
Why Perform an In Service Withdrawal?
Normally withdrawals from an employer sponsored plan prior to 59 1/2 will incur a 10% penalty.
Hardship Distribution Exceptions
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):
Medical expenses for the employee or their spouse, dependents, or a beneficiary
Costs directly related to the purchase of the employee’s principal residence, including mortgage payments
Tuition and all related post-secondary educational costs, including room and board, for the employee, spouse, children, spouse’s children, or a beneficiary for the next 12 months
Payments necessary to prevent the foreclosure of the employee’s principal residence or eviction of the employee from that residence
Funeral expenses for the employee, their spouse, their children, or a beneficiary
Certain expenses to repair damage to the employee’s principal residence
Non Hardship Distributions
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.
What Types of Retirement Accounts offer In Service Withdrawals?
Pensions are a defined benefit plan may allow for in service distributions. However they typically have more stringent vesting requirements that can complicate matters.
401ks are probably the most common type of employer sponsored retirement plan in the united states. Many of them will allow 401k in service distribution options.
403bs, 457s, TSPs, SEP IRAs, and Simple IRA's may also allow for in service distributions and withdrawals. (Note: Simple IRA's have vesting schedules that must be accounted for)
Your Employer Doesn't Want You To Perform an In Service Distribution or In Service Withdrawal
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.
How To Find Out if Your Employer Sponsored Retirement Plan Allows In Service Distributions and In Service Withdrawals
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:
In service distribution
In service withdrawal
In service distribution 401k
In service distribution from 401k
In service 401k distribution
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:
Does my plan allow for in service withdrawals?
If yes, are there any rules or conditions I must follow?
Are there specific types of accounts that i am restricted to moving the money into?
Are there tax consequences to this action?
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.
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