Whether or not you can roll funds from a 401(k) or an individual retirement account (IRA) into a more liquid investment fund depends on a few factors. You may be able to change your investments in an IRA, but doing so within a 401(k) is a different matter, as these plans typically have limited options from which to choose.

Speaking in general terms, IRA and 401(k) assets that are distributed and not rolled over to another IRA or eligible retirement plan will be subject to income tax. They may also be subject to an early-withdrawal penalty of 10% if you are under age 59½.

Key Takeaways

  • You can typically buy and sell a variety of investments in an IRA, which makes it easier to invest in a more liquid fund.
  • The assets available for investment in an IRA will largely depend on the custodian or broker you have chosen to house your account.
  • 401(k) plans commonly have limited investment options, but under very specific circumstances you may be eligible to withdraw funds before retirement and invest the money elsewhere.

IRA Rollovers

You may be able to change your IRA investments or even transfer your account to another financial institution that offers the types of options you prefer. Check with your financial institution regarding its policies for allowing transfers, as there are some IRAs that require a minimum investment period in order to avoid early termination charges. As long as a qualified rollover is made within 60 days of withdrawing the funds to be rolled over, there is no early withdrawal penalty.

Within your IRA plan, you can invest in any number of assets, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Some IRA custodians even allow for commodities or real estate. You may have to pay your custodian a broker fee or commission to trade inside of it, but as long as it stays in your IRA, there are no tax penalties.

401(k) Withdrawal-Triggering Events

The 401(k) plan is a different matter. You are able to withdraw assets from your 401(k) plan only if you experience a triggering event (see the list below). If you do experience one, you may roll your 401(k) assets into a traditional IRA or another qualified plan.

Typically, 401(k) plans offer participants a limited number of investment options, such as a handful of mutual funds and sometimes annuity contracts and company stock, so rolling over funds to another retirement account can result in more choice.

For most 401(k) plans, the triggering events are the following:

  • Reaching retirement age: This is generally age 59½, but it could be earlier or as late as age 65.
  • Termination of employment: You are no longer employed by the company that offers the 401(k) plan in question.
  • Death: In this case, your beneficiaries are allowed to distribute your assets.
  • Disability: The document that governs the 401(k) plan generally provides a definition of “disability,” which may vary from plan to plan.
  • Termination of the plan: Your employer terminates the 401(k) plan and does not replace it with another qualified plan.

The IRS imposes a 10% penalty on funds withdrawn early to deter savers from dipping into their retirement assets prematurely; however, there are certain exceptions to the rule in which early withdrawals are allowed.

In-Service Withdrawals

If none of the above triggering events occurs, then you cannot withdraw assets from your 401(k) account unless the plan allows for an in-service withdrawal (one that can occur in the absence of a triggering event).

Some 401(k) plans limit in-service withdrawals to certain circumstances. You may, for example, be allowed a withdrawal if you need the money to pay medical expenses, your mortgage, or rent. Your plan administrator will be able to explain whether your plan has these provisions and any applicable limitations.

Impact of the CARES Act

As a result of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020, meant to provide economic relief amid the COVID-19 pandemic, certain temporary changes have been put into place for the tax year regarding retirement plan withdrawals and tax liability. The following changes apply to eligible participants.

An eligible participant is a person who has been diagnosed with COVID-19, has a spouse or dependent diagnosed with COVID-19, or has experienced a layoff, furlough, reduction in hours, or inability to work due to COVID-19 or lack of childcare because of COVID-19.

The law states that eligible participants can take an early withdrawal of up to $100,000 from 401(k)s, 403(b)s, 457s, and traditional IRAs without paying a 10% penalty. The act also puts on hold the mandatory 20% tax withholding that normally accompanies early distributions from workplace retirement plans, including 401(k)s. IRAs don't have an early withdrawal mandatory tax withholding requirement.

An individual has up to three years to pay the taxes on the early withdrawal or to redeposit the money back into their retirement account. Usually, money borrowed from an account must be paid back within 60 days.

Retirement plans are not required by law to accept this modification of early withdrawal rules, but most plans are expected to follow suit.

The law covers withdrawals made between January 1, 2020, and January 31, 2020.

The Bottom Line

You should consult with a competent financial advisor or investment professional before taking action on any of the above scenarios. There is usually a cost associated with any consultation (unless you can get it for free from your employer), but it may be well worth it.