Many employees love the convenience of investing in 401(k)s, 403(b)s or other qualified retirement plans. With automatic contributions, prepackaged investment choices and employer matching, the system enables an easy retirement savings process.
But many feel stuck with the inflexibility of 401(k)s. The investment choices can be limited and may only include expensive actively managed mutual funds or target-date funds. Depending on the individual, these options might not be the best retirement strategy.
This is especially true for individuals who are rapidly approaching retirement and need to tighten the details of their plan before “making the leap.” For those diligent enough to develop a financial plan with an advisor or financial planner, chances are that their professionally managed investment portfolio has worked around these limited options within the company’s plan. When approaching retirement, it becomes even more important to take control of your financial decisions, but the rigid structure of company plans can be an obstacle. (For related reading, see: What to Do to Prepare for Retirement.)
For participants of a certain age, there is often an easy solution of which many are unaware. IRS guidelines allow individuals at age 59 ½ (or older) to take an “in-service withdrawal”, where the plan distributes their assets into a rollover IRA or other qualified savings vehicle, such as an annuity. This can be a very helpful strategy, and here are some answers to common questions about this approach. (For more, see: Why Rollover Your Retirement Assets into an IRA?)
Why Would I Withdraw Early from My 401(k)?
To have complete control over your investments and retirement plan, and not be bound by the limitations of canned investment options.
IRAs provide an entire universe of investment choices that can be used in order to build a well-diversified retirement portfolio. For example, where a company plan might offer a menu of one or two fixed-income mutual funds, an IRA can hold individual bonds, ETFs or nearly any mutual fund that is accessible through an advisor. IRAs can also access asset classes that are seldom offered in company plans, such as stocks, non-traded REITs, and other alternative investments. With the availability of individual investments and almost any asset class, a professionally managed IRA provides a more robust and customized retirement portfolio.
Depending on the individual circumstances, the investment strategy may vary, but a professionally managed portfolio tailored for you by a fiduciary wealth advisor should be a better option than what a company retirement plan affords. (For related reading, see: Why the Fiduciary Standard Is Important.)
Isn’t it Cheaper to Just Leave It until Retirement?
Actually, a company plan often costs more than a professionally managed portfolio and lacks the comparable value of professional advice and management. With the right advisor, management fees in IRAs are transparent and fund administrative fees are controllable.
Company retirement plan fee structures are many times somewhat of a “black box”, and this has resulted in recent legislation to disclose hidden fees and baked-in components for administrative and record keeping services. With company plans it is very difficult to quantify cost, let alone control it.
While advisors charge a management fee, this cost goes directly towards providing custom investment advice for the individual client—a tangible value to the investor. When coupled with a competent advisor’s due diligence on individual fund expenses and lack of conflict or commission motive, the total account expenses can be reduced and actively managed. Taken in total, the managed IRA fee structure can provide a much better value than these rigid company retirement plan programs. (For related reading, see: Why the Need for Human Advisors Will Never Die.)
Aren’t There Penalties and Taxes on Early Withdrawals?
No, as long as the plan participant is 59 ½ or older and transfers into a tax-deferred account, there are no taxes or early withdrawal penalties on in-service distributions. But similar to rollover rules, the IRA must receive the funds within the traditional 60-day window. (For more, see: 4 Mistakes to Avoid with Your Retirement Plan.)
But What About Company Matching?
So long as employment continues, the company will continue to match your savings. Because the match is based on contributions, rather than account values, an in-service withdrawal will have no effect on your matching benefit as long as you remain employed and continue making contributions. You can keep investing those savings into the plan-provided options until you stop working, or you can make annual qualified in-service withdrawals once the match has been fully vested.
Can I Still Borrow Against My Account?
There is no corresponding ability to borrow against an IRA, and while you may continue to borrow against your company plan if available, there will be a decreased borrowing ability due to a lower account value post-distribution. Keep in mind however, that borrowing against a 401(k) is not generally recommended by financial planners and depending on the situation, there should be other sources of financing available.
The key advantages of an in-service withdrawal are getting an early jump on implementing a specific retirement investment strategy and having additional flexibility and control over your retirement funds. Perhaps the most notable benefit is putting the account under the management of a professional investment advisory firm. With full discretion over your investments, an advisor can keep the account in balance and possibly employ timely tactical moves that aren’t common in 401(k) account management. For many inevitable retirees, this presents a clear upside to the very basic, (and expensive), options available within most company retirement plans.