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Remember the good old days of whistling while you work in regards to your 401k?  Your company used to have a very nice match to your 401k.  Your balance was at at all time high and retirement seemed like just over the horizon.   Then 2008 came along and the whistling turned into more of a whimper.  Don’t worry, I was whimpering, too.   For those that are 59 1/2 and still working, I might have a reason for you to whistle again.  The reason behind it is called the 401k in-service distribution.

I took a call from a client recently whose employer was getting ready to switch 401k providers again (3 times in the last 5 years) and was frustrated with the new investment options.   He is over 59 1/2 and had heard that he might be able to rollover his 401k to an IRA and also continue to fund his 401k.   I was excited to share with him that he in fact could do this and that the procedure was called an in-service distribution.

Rules on 401k In-Service Distribution

1. First things first, you HAVE to be 59 1/2.  No matter how much you dislike your current plan and you want to withdrawal it all,  it’s not an option until then.
2. This doesn’t just apply to 401k’s.  Any types of retirement plans will work, too.  This includes 403b’s, 457″s and pensions, too.
3. Be sure to rollover the money to an IRA if you don’t need it.  By doing a 401k in-service withdrawal you will taxed.

Reasons to Do a 401k In-Service Distribution

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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. Here are some reasons that you might want to:

• 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.

Disadvantages of 401k 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 protection, 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. Be sure to consult wit your plan administrator before implementing this.
• Cost — Fees related to having your own IRA could be more costly than the investment options inside the 401k.
• 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.  This can become more of an issue in regards to doing a Roth IRA Conversion.

*Restrictions, penalties and taxes may apply.  Unless certain criteria are met, Roth IRA owners must be 59 1/2 or older and have held the IRA for 5 years before tax-free withdrawals are permitted.

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

photo credit: mujitra (´･ω･)

Occasionally, I have had people inquire to me about what happens when their company changes 401(k) providers. Usually when such an event occurs, there is a lot of confusion and uncertainty about what is going to happen with their money. To prevent you from making any ill advised decisions, please read more.

It Might Not Be That Bad

First, I’d like to give some reassurance that just because your company is changing 401(k) providers it is not necessarily a bad thing. Depending on your current investment selections, your new 401(k) may have better options, could be less costly to you, and you may get better service than you did with your previous provider. Obviously, everything I just stated could be the exact opposite, so you never know what could happen.

How the change works

You have just  received the change notice and you’re scared out of your mind because you have no idea what it all means, take a breath. <Gasp> Okay, realize that you don’t have to do anything. Whatever your investment selection was in the current plan should convert over to the new plan. For example, if you were in a balanced model that had you 60% stock and 40% bonds, you should be in the same type model in the new plan, just with different options. This conversion period is what they call the black-out period which means you won’t be able to make any changes to your 401k allocations. So if you want to convert it all to money market because you think the market is going to tank, do it now before it’s too late.  And if you have some sixth sense of know that this is going to occur, please share with the rest of us so we can follow suit.

401k Options

But as an employee, you do have a few choices on what you can do.

1. If you are over the age of 59 1/2, you can do what is called an in-service distribution. I wrote about this in a previous post that talks about some of the pros and cons of doing such. If you are absolutely sure that your new 401(k) provider is somebody that you do not want to have your money invested with, then this may be an option that is best suited for you.

2. If you are under the age of 59 1/2, you are pretty much limited on what you can do with your existing 401(k). One option is if you are currently fully maximizing your 401(k) and putting in more than it requires to receive your match, you could then just put in the minimum to get the match and divert the remaining into your own personal IRA, either a traditional or a Roth. (You could not add any money to the new 401k at all, but you should always take the company match no matter what). Doing so would then have the least amount of money in the 401(k), which you are trying to stay out of, and then having more control with your investment selections inside the IRA. Once you then retire or leave your current employer, you will be able to roll over your 401(k) out of the plan that you were trying to avoid.

Unfortunately, under the age of 59 ½ you are limited on your choices. Don’t be too disgruntled in the beginning. Do your research on the new plan and meet with a Certified Financial Planner™ to make sure you are properly diversified.

Securities office through LPL Financial, Member FINRA/SIPC