A client of mine was looking to retire May of 2008. But when the market turned in the wrong direction, he decided to postpone his retirement. His 401k provider had been switched a couple years back and was not really satisfied with his current options. He was over 59 ½ and decided one day to take advantage of an in service distribution.
*Update: You can do an in service distribution with a pension, too.
In Service Distribution- Should You or Shouldn’t You
An in service distribution allows you to rollover your vested balance from your profit sharing plan to an IRA. You will have to determine first if you are eligible. Some plans may restrict from doing so. Potential advantages may include:
- Control— Who doesn’t like control? With an IRA, you are the account owner and have more control over your assets, free from the restrictions your employer-sponsored plan can impose.
- Diversification — Many employer-sponsored plans offer limited investment options. In contrast, most IRAs typically provide a wider range of investment choices across virtually every asset class. This flexibility can help you better diversify your retirement assets to meet your individual investment goals.
- Beneficiary options — Typically, IRAs allow non-spouse beneficiaries to “stretch” an inherited IRA over their lifetimes. This type of beneficiary distribution option is not available in most employer-sponsored plans, which may limit distribution choices for your beneficiaries.
Possible Disadvantages of In Service Distributions
With every advantage there may be disadvantages. Please consider:
Age limitations — In qualified plans, the age 55 rule allows participants who stop working at age 55 or older to take distributions without the 10% IRS premature distribution penalty. In an IRA, you may not take distributions until age 59½. For this reason, if you plan to retire early, you may want to preserve penalty-free access to your retirement funds by not moving all of your 401(k) assets to an IRA before retirement.
- NUA— Net Unrealized Appreciation (NUA) tax treatment is not an option for distributions from IRAs. Therefore, if you hold highly appreciated company stock in your employer-sponsored plan, the rolling of that stock to an IRA eliminates any ability you may have to take advantage of NUA tax treatment.
- Creditor protection — While IRAs now have federal bankruptcy protection3, other IRA creditor protection is still determined by state laws. Qualified plan assets continue to have broad federal creditor protection.
New contributions to your existing plan — Taking an in-service distribution may affect your ability to contribute to your employer-sponsored plan. - Cost — Fees related to an IRA are disclosed in the applicable product prospectus, contract offering or other disclosure document. Typically, qualified plans do not charge fees for trading within the account, mutual fund loads or commissions. Investment expenses in a qualified plan may also be lower due to institutional pricing.
- After-tax dollars — After-tax dollars are generally segregated in a qualified plan, and can often be distributed separately. However, after-tax dollars complicate things if rolled to an IRA. If you move after-tax money into an IRA, that money becomes part of the non-deductible “basis” of the IRA and will not be separately accessible. To avoid paying tax again on your IRA “basis” when you take an IRA distribution, you must maintain careful records of the “basis” in your IRAs.
All in all, it made sense for the client in this situation. We were not able to get the proper diversification for his risk tolerance in the 401k, but could do so within his IRA.
Securities offered through LPL Financial. Member FINRA/SIPC
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