Retirement Meditation #26: Should I take an in-service withdrawal from my retirement plan?

Insights | Retirement Meditation #26: Should I take an in-service withdrawal from my retirement plan?

Author: Paul A. Carl, CHSA, CPFA Vice President, Retirement Plan Consulting, Registered Representative

The plan administrator called with a dilemma. A critically important employee stood in her office holding a foreclosure notice. Because the company’s retirement plan permitted neither participant loans nor hardship withdrawals, the employee threatened to quit to get a 401(k) distribution. Additionally, as a matter of policy, the company itself did not make loans or payroll advances to employees. The plan administrator wanted to know what other plan options might be available. A little investigating and it turned out that the 401(k) plan did allow in-service withdrawal of rollover money. The employee had rolled over a previous employer’s 401(k) plan into this company’s plan. The questions now became: How much to withdraw? What would be the tax effects? Did the employee want to permanently remove funds from his accumulated retirement savings?

Some plans offer no in-service withdrawal options while others offer three or more. The most popular in-service withdrawal types are:

  • Hardship withdrawals
  • Age 59-1/2 in-service withdrawals
  • Contribution-source specific withdrawals, such as in the example above

Plans offering hardship withdrawals most often adopt the IRS safe harbor standards for allowing participants to take a hardship withdrawal. By following the IRS safe harbor standards, the plan administrator is limiting hardship withdrawals to certain reasons and creating a fiduciary safety-net in the administration of the hardship provisions. 

Plans offering age 59-1/2 in-service withdrawals permit participants aged 59-1/2 or older to take distributions from their retirement plan while they continue employment. These distributions can be rolled over into an IRA or taken as taxable. The key factor? At age 59-1/2, the 10% excise tax penalty on early withdrawal no longer applies. However, personal income taxes can and will apply to taxable distributions.

Contribution-source specific withdrawals are most often related to the rollover source. These are plan assets the participant electively rolled into the employer’s plan from an IRA or a former employer’s plan. Most often, but not always, the plans designed to permit incoming rollovers will also allow those rollover funds to be withdrawn at any time. They can be distributed into an IRA with no tax consequences, or they can be taken as taxable. If the participant taking the taxable in-service withdrawal is younger than age 59-1/2, the 10% tax penalty (and personal income taxes) will apply. 

Regardless of the type of in-service withdrawal, the biggest issue for most participants is the permanent removal of accumulated retirement savings. In-service withdrawals, especially those taken as taxable, are effectively removed from the participant’s retirement savings, which could cause a later hardship especially as the participant nears or enters retirement. Remember, these funds taken as taxable distributions are no longer available to earn future growth and no longer available at retirement.

Will you let your retirement savings success be hampered by an in-service withdrawal?

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