What You Need To Know When Taking A Withdrawal From Your 401k

As anyone who has ever enrolled in a company’s 401(k) retirement plans knows, it’s not easy to take out the money before you have left the workforce. 

While many 401(k) plans allow participants to take withdrawals while they are still employed (commonly known as in-service withdrawals or distributions), they generally are permitted only in specific situations. These include large medical expenses, education costs or the purchase of a home. 

But some 401(k) plans allow in-service, non-hardship withdrawals once the employee has reached age 59½ or have met other requirements specified by the plan. About 70% of plans available in the U.S. offer this option. You can find out whether your plan has an in-service withdrawal provision, ask for a copy of the plan’s Summary Plan Description or look at your year-end statement. 

What are the advantages of taking an in-service withdrawal or distribution if you don’t need the money for qualifying expenses? There are several, including the following: 

• You have more choices when investing for retirement. If you transfer the funds to an Individual Retirement Account (IRA), you can have more control over your money. 
• Your investment options can markedly increase when you are free of investment restrictions included in many 401(k) plans. You get more opportunities for building a diverse portfolio and increased asset allocation flexibility. 
• Your beneficiary who is not a spouse can benefit too but using a “stretch” IRA option that extends tax-deferred benefits to non spouses. This distribution option is usually not available in company-sponsored 401k plans. * 
• If your company plan allows it, you can convert AFTER-tax contributions to your 401(k) to a traditional IRA and ask your financial advisor to help you convert that into a Roth IRA. 

But there are some downsides to in-service distributions. For example, in a 401(k), plan participants who quit working at age 55 can take distributions without incurring the 10% IRS penalty for early distributions. With an IRA, you have to wait until age 59 ½ . So you won’t want to convert your company plan to an IRA if you plan to retire early. Some other reasons to sidestep the IRA route include: 

• If you own company stock in your 401(k) and it has appreciated greatly, a conversion to an IRA will deprive you of an important tax break upon distribution. Be sure to consult with your tax advisor before swapping your 401(k) for an IRA. 
• If you find yourself needing to file for bankruptcy, know that some IRAs will not be protected from creditors, according to laws in your state. 
• Your company may not allow you to make future contributions to your 401(k) if you take an in-service distribution. Be sure to check with your company’s rules before rolling over assets into an IRA. 
• The administration fees could be considerably higher than with your company’s plan, so always check with your financial advisor before taking such a step. 
• If you have after-tax dollars in your company plan, you need to be especially careful to ensure that after-tax money is not lumped in with before-tax dollars in your IRA. You will need the help of a financial advisor to be sure the rollover is handled correctly and you will need to keep careful records to show the IRA. This is especially crucial when you do a Roth IRA conversion **. 

Did you roll in a previous employer 401k plan into your existing 401k plan? Some companies allow participants to distribute their rollover account balance any time and these in many cases are unrestricted. In these cases, there could be Roth IRA conversion or “backdoor” Roth IRA opportunities. Again, check with your financial consultant before proceeding. 

Can an employee take distributions from a pension plan? Generally, no, not until retirement. This applies to nearly all types of pension plans—Defined Benefit, Money Purchase and Target Benefits. There are some provisions for in-service distributions beginning at age 62 even if you are still working, but not before, not even for financial hardship.

*“Stretch IRA” is a marketing term implying the ability of a beneficiary of a Decedent’s IRA to withdraw the least amount of money at the latest allowable time in order to maintain the inherited IRA assets for the longest time period possible. Beneficiary distribution options depend on a number of factors such as the type and age of the beneficiary, the relationship of the beneficiary to the decedent and the age of the decedent at death and may result in the inability to “stretch” a decedent’s IRA. Illustration values will greatly depend on the assumptions used which may not be predictable such as future tax laws, IRS rules, inflation and constant rates of return. Costs including custodial fees may be incurred on a specified frequency while the account remains open. 

**Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA. 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. 

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.