In-Service Withdrawals: The 12 Frequently Asked Questions
Employee In-Service Withdrawal FAQs
In most 401(k) or 403(b) plans, employees can take a distribution of their benefits upon employment termination. Some employers also allow in-service distributions, enabling employees to withdraw from their account while still employed. This FAQ discusses several of the options that are available.
1. What is an in-service distribution?
An in-service distribution is a withdrawal from a retirement plan while the employee is still employed.
2. When can an employee receive a distribution from a 401(k) or 403(b) while still working?
It depends. A plan may (but is not required to) allow participants to receive in-service distributions. In addition, certain conditions must be satisfied which are set forth under the Internal Revenue Code and regulations.
Quick Facts
1. Eligibility: In-service withdrawals allow employees to access retirement funds while still employed.
2. Age Restriction: For most retirement accounts, in-service withdrawals without penalties are allowed starting at age 59½.
3. Rollovers: In-service distributions are generally eligible for rollover, except for hardship withdrawals.
3. Are the rules different depending upon the type of contribution money sources?
Yes. Employee elective deferrals (such as employee pre-tax and Roth after-tax contributions) can only be distributed while a participant is still working under limited circumstances. The following withdrawals are permissible from these contributions, if provided for under the plan document:
- Loans
- Hardship withdrawals, and
- In-service distributions on or after the date a participant has attained age 59 ½
4. Are there any restrictions as to when an employee can take an in-service distribution?
Yes, there are, and the restrictions vary based on the contribution money source, e.g. employee deferrals, profit sharing, etc. Those restrictions are generally based on factors such as age and service.
5. What is the significance of age 59 ½ when it comes to in-service distributions?
That is the earliest age the law allows a participant to take an in-service distribution from his or her 401(k) deferral account and, if applicable, accounts holding Qualified Nonelective Contributions (QNECs – includes safe harbor nonelective contributions) and Qualified Matching Contributions (QMACs – includes safe harbor matching contributions).
At age 59 ½, the 10% early withdrawal penalty no longer applies to most distributions.
6. Does that mean that other types of plan accounts are available at a younger age?
Yes. Accounts holding other types of contributions such as non-safe-harbor matching and profit sharing contributions can be made available for in-service distribution at any age. Keep in mind that the 10% early withdrawal penalty does apply in that case.
In our experience, most plans limit in-service distributions to age 59 ½.
7. Are in-service distributions eligible for rollover?
Generally, yes. With the exception of hardship distributions, any of the in-service distributions described above are eligible for rollover.
8. Are in-service distributions subject to the additional 10% income tax for early withdrawals?
Yes. Unless the participant has attained age 59 ½, the taxable portion of the distribution is generally subject to the additional 10% income tax. There are exceptions to this rule if the participant is disabled (as defined under the Internal Revenue Code) or if the distribution is a qualified reservist distribution.
9. What qualifies as a “hardship” distribution?
The regulations provide “safe harbor” rules, which most plans follow. Under these rules, hardship distributions may be made for the following reasons:
- To prevent foreclosure or eviction from a participant’s principal residence
- To purchase a participant’s principal residence (excluding mortgage payments)
- To pay for post-secondary education for an employee, his spouse, children or dependents for the next 12 months
- To pay for unreimbursed medical expenses that would otherwise be deductible (without consideration to the deduction limit) for a participant, his spouse, children or dependents
- To pay for funeral expenses for a participant’s deceased parent, spouse, child or dependent
- To pay for expenses necessary to repair a participant’s principal residence as a result of a casualty
- Expenses incurred as a result of a natural disaster in a federally declared disaster area
- Medical, post-secondary educational, and funeral expenses for a participant’s primary beneficiary
10. Are in-service withdrawals from Roth accounts taxable?
It depends. Roth contributions are not taxed when distributed, but the related earnings may be unless the distribution is a “qualified distribution”. In general, a distribution is a qualified distribution only if the distribution is being made on account of death, disability or attainment of age 59 ½ and the participant has had a Roth account under the plan for at least 5 years.
Distributions that are rolled over to a Roth IRA are not taxable.
11. If a plan allows in-service distributions, can the provisions be removed?
A plan can remove a hardship distribution feature at any time; it is not a protected benefit. The other types of in-service distribution options discussed above are protected under the law. What this means is that any of these provisions may be removed prospectively; however, the participant account balances as of the effective date of the change must continue to be eligible for in-service distribution under the plan’s prior provisions.
12. Other than age, are there other factors a plan can use to allow in-service distributions?
Yes. The two most common factors beyond age are the length of time an employee has been a participant in the plan and the amount of time an account has accumulated in the plan. These options are only available for match, profit sharing, and rollover accounts.
Five Years of Participation
This option allows any employee who has been a participant for at least 5 years to take an in-service distribution. The five-year clock is typically tracked on an elapsed time method, so if the participant joined the plan on January 1, 2017, he or she completes five years of participation on January 1, 2022 (assuming continuous participation throughout that time frame).
Two Years of Accumulation
This option allows a participant to take an in-service distribution of amounts that have been in the plan for at least two years. This one can be a little tricky to track because it runs on a rolling two-year period based on the date contributions were actually deposited to the plan. So, for example, if a plan sponsor deposits its 2017 profit sharing contribution on September 15, 2018, the earliest date that amount would be available under this option is September 15, 2020 (two years after the deposit date).
Final words
401(k) and 403(b) distribution rules can be complex and often come with strict restrictions to discourage early withdrawals. Before making any decisions about accessing your retirement savings, consult with a CPA or financial advisor. They can guide you in structuring a distribution plan that minimizes taxes and helps you make the most of your savings.
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