In-Service Withdrawals from 401(k) Plans

You may be familiar with the rules for putting money into a 401(k) plan, but are you familiar with the rules for taking money out? Federal law limits the withdrawal options that a 401(k) plan can offer. Some 401(k) plans even offer fewer withdrawal options than the law allows, or provide that you don't take money out at all until you leave employment. However, many 401(k) plans are more flexible.

First, consider a plan loan

Many 401(k) plans allow you to borrow money from your own account. A loan may be attractive if you don't qualify for a withdrawal, you don't want to incur the taxes and penalties that may apply to a withdrawal, or you don't want to permanently deplete your retirement assets.

In general, you can borrow up to one half of your vested account balance (including your contributions, your employer's contributions, and your earnings), but not more than $50,000. You can borrow the funds for up to five years, or longer if the loan is to purchase your principle residence. In most cases, you repay the loan through payroll deduction, with principal and interest flowing back into your account. Keep in mind, though, that when you borrow, the unpaid principal of your loan is no longer in your 401(k) account to work for you.

Withdrawing your own contributions

If you've made after-tax (non-Roth) contributions, your 401(k) plan can let you withdraw those dollars (and any investment earnings on them) for any reason, at any time. If your plan allows, you can withdraw your pre-tax and Roth contributions (that is, your "elective deferrals"). However, you can only do so for one of the following reasons:

• You attain age 59½
• You become disabled
• The distribution is a "qualified reservist distribution"
• You incur a hardship

Hardship withdrawals are allowed only if you have an immediate and heavy financial need, and only up to the amount necessary to meet that need. In most plans, you must require the money to:

• Purchase your principal residence, or repair your principal residence damaged by an unexpected event (e.g., a hurricane)
• Prevent eviction or foreclosure
• Pay medical bills for yourself, your spouse, children, dependents, or plan beneficiary
• Pay certain funeral expenses for you, your spouse, children, dependents, or plan beneficiary
• Pay certain education expenses for yourself, your spouse, children, dependents or plan beneficiary

Keep in mind that hardship withdrawal can't be rolled over. So think carefully before making a hardship withdrawal.

Taxation

When you withdraw your own pre-tax contributions, company contributions, and investment earnings, they are subject to income tax. If you have made any after-tax contributions, they will be nontaxable when you withdraw them. Any withdrawal you make will contain the same proportion of taxable versus nontaxable dollars as the proportion of each that makes up your account.

Your Roth contributions and investment earnings on them are taxed separately. If your distribution is "qualified," then your withdrawal will be entirely free from federal income taxes. If your distribution is "non-qualified," then each withdrawal will be deemed to carry out a proportional amount of your nontaxable Roth contributions and your taxable investment earnings. A distribution is considered qualified if you satisfy a five-year holding period, and your distribution is made either after you’ve reached age 59½ or after you’ve become disabled. The five-year period begins on the first day of the first calendar year that you make your first Roth 401(k) contribution to the plan.

The taxable portion of your distribution may be subject to a 10% premature distribution tax, in addition to any income tax due, unless an exception applies. Exceptions to the penalty include distributions after age 59½, distributions on account of disability, qualified reservist distributions, and distributions to pay medical expenses.

Rollovers and conversions

Rollovers of non-Roth funds

If your in-service withdrawal qualifies as an "eligible rollover distribution" (and most do, except for hardship withdrawals and required minimum distributions after age 70½) you can roll over all or part of the withdrawal tax free to a traditional IRA or to another employer's plan that accepts rollovers. In this case, your plan administrator will give you a “402(f) notice” explaining the rollover rules, the withholding rules, and other related tax issues. (Your plan administrator will withhold 20% of the taxable portion of your eligible rollover distribution for federal income tax purposes if you don’t directly roll the funds over to another plan or IRA.)

You can also roll over ("convert") an eligible rollover distribution of non-Roth funds to a Roth IRA. Some 401(k) plans even allow you to make an "in-plan conversion" -- that is, you can request an in-service withdrawal of non-Roth funds, and have those dollars transferred into a Roth account within the same 401(k) plan. In either case, you'll pay income tax on the amount you convert (less any nontaxable after-tax contributions you've made).

Rollover of Roth funds

If you withdraw funds from your Roth 401(k) account, those dollars can only be rolled over to a Roth IRA, or to another Roth 401(k)/403(b)/547(b) plan that accepts rollovers. However, be sure to understand how a rollover will affect the taxation of future distributions from the IRA or plan. For example, if you roll over a nonqualified distribution from a Roth 401(k) account to a Roth IRA, then the Roth IRA five-year holding period will apply when determining if any future distributions from the IRA are tax-free qualified distributions. This means that you won't get credit for the time those dollars resided in the 401(k) plan.

Be informed

You should become familiar with the terms of your employer's 401(k) plan to understand your particular withdrawal rights. A good place to start is the plan's summary plan description (SPD). Your employer will give you a copy of the SPD within 90 days after you join the plan.

This information was developed by Broadridge, an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results.

Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. May be subject to state, local, and alternative minimum tax. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.