In Service Distribution- 401k Rollover While You’re Still Working

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 an 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 type of retirement plan 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 be taxed.

Reasons to Do a 401k In-Service Distribution

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 with your plan administrator before implementing this. Learn more here about Roth IRA contribution limits.
• 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.

Where to Rollover

If you do not have a brokerage account already in place. These are the top providers to set up a rollover to an IRA:

*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.