In-Service Withdrawal: Definition, Rules, Taxes & Penalties

What Is an In-Service Withdrawal?

An in-service withdrawal occurs when an employee takes a distribution from a qualified, employer-sponsored retirement plan, such as a 401(k) account, without leaving the employ of their company.

This may occur without a tax penalty any time after the employee reaches age 59½, or if the employee withdraws up to $10,000 to purchase their first home, declares a hardship, or establishes extreme financial need. In some cases, in-service withdrawals can be made without these events occurring.

Not every retirement plan allows in-service withdrawals, but in 2019, about 70% of those available in the US did offer this option under certain conditions.

Key Takeaways

  • In-service withdrawals refer to taking special distributions from a 401(k) account.
  • These distributions occur while the employee is still employed.
  • The distributions are normally available for hardship cases.
  • Special rules allow some plan participants to take distributions even without hardship.

Understanding In-Service Withdrawals

By law, normal withdrawals from retirement plans can be made as a result of employment change, hardship and documented financial need, or once the employee has reached 59½ years of age.

In-service withdrawals are a little different. If the plan allows in-service withdrawals, then an employee can take a distribution merely for the purpose of pursuing different investment options that they deem more suitable for them. This is usually done in the form of an allowable rollover from the plan to a previously existing 401(k) account or a new traditional IRA account.

This provision can be tricky. For example, rolling over savings from a 401(k) plan to a traditional IRA is allowed by law if the money being moved is from employer contributions (either matched money or profit-sharing accumulations). The money being rolled over cannot come from pre-tax contributions unless the employee is 59½ years old or older. So the solution is to know precisely what your plan allows and what it does not. Finding out such details might be a little harder than it sounds for some employees.

It doesn't take much to imagine that any company administering a company-sponsored retirement plan has the incentive to keep participants from taking money out of their accounts early for any reason. The government agrees that employees who are saving for retirement should be very careful about withdrawing money early under any circumstances.

These two factors combine to inhibit your ability to find out the details of your plan's in-service withdrawals because the administration company doesn't exactly advertise such provisions and the government doesn't require them to do so. To find the information you need, you'll likely have to search a bit online or make a phone call to your 401(k) helpline.

What to Ask Your Plan Administrator About In-Service Withdrawals

If you don't like your current investment options and want to move some or all of your 401(k) money to an IRA that has better choices, you'll need to search for the FAQ pages or call and ask direct questions of the company which manages your retirement plan. Look for the answer to these four questions:

  1. Does the plan I am enrolled in allow for in-service withdrawals?
  2. If so, what conditions apply?
  3. What type of account can I move this money into?
  4. What are the tax consequences of this withdrawal?

Since only about 30% of employer-sponsored plans in America don't offer this option, it is worth looking into if you want more investment options. Once you've determined that your plan does allow non-hardship, in-service withdrawals, you'll want to pay attention to the tax consequences of such a decision.

Typically, the distribution must be made to a Traditional IRA to avoid generating new taxes, but oftentimes, a distribution to a Roth IRA can be allowed if you are willing to pay the taxes that will come from such action.

Some people might consider paying taxes or penalties worthwhile if their investment options were good enough, but most investors and financial advisers would agree it is generally not considered a sound choice to do so. Still, it is true that individual circumstances vary and no one can say that one single choice is precisely best for all investors.

That being said, you should be very careful about your choices in this area. Many investors have lost significant money chasing after investments that suggest higher than normal rates of return, and in hindsight, paying taxes for the privilege of losing money can feel like adding salt to an open wound.

Tax Implications of In-Service Withdrawals

Most withdrawals made from a qualified employer-sponsored retirement plan before reaching age 59½ will come with a 10% early-withdrawal penalty tax on the amount being distributed. This is in addition to applicable federal income and state taxes. However, the 10% premature penalty tax can be waved if the in-service withdrawal or hardship distribution is used to cover medical expenses that exceed 7.5% of adjusted gross income (AGI) or if it is used to make a court-ordered payment to a divorced spouse, child or dependent. Other exemptions are defined by the IRS. 

But since non-safe harbor employer matching contributions and profit-sharing contributions can be distributed at any age, and voluntary contributions can be withdrawn at any time, in-service withdrawals can be used if you have alternative investment vehicles you clearly understand and are willing to manage.

If you can find the documentation, your plan administrator's firm should spell out the types and treatment of each eligible in-service distribution in what is called the summary plan description or the plan document itself. Tax information may not be specified there since specific tax details are set by the IRS.

What Types of Retirement Accounts Allow In-Service Withdrawals?

Today, most defined-contribution plan types (such as 401(k), 403(b)/457(b), and thrift savings plans) allow for in-service withdrawals. Depending on how the plans' rules and how it is structured, there may be various limitations or qualifications on when or how such withdrawals can be made.

When Can You Start to Take In-Service Withdrawals?

You can begin taking in-service withdrawals from a retirement account if you are still employed at age 59½. If you take it out sooner, you will be subject to a 10% early-withdrawal penalty (in addition to any deferred taxes due).

Can You Contribute to a Retirement Plan if You Are Also Taking In-Service Withdrawals?

Yes, you can so long as you do not contribute more than the annual limit (ignoring any withdrawals). Note, however, that withdrawals will be subject to income tax. In general, this strategy, while allowable, may not make much sense.

Article Sources
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  1. Plan Sponsor Council of America. "64th Annual Survey Report."

  2. Lord Abbott. "How to Access Your Retirement Account While Still Employed with In-service Distributions."

  3. Internal Revenue Service. “401(k) Resource Guide - Plan Participants - General Distribution Rules.”

  4. Financial Industry Regulatory Authority. “401(k) Rollovers.”

  5. Internal Revenue Service. “Section 401(k) Compliance Check Questionnaire Final Report, March 2013,” Page 6.

  6. Internal Revenue Service. “Retirement Topics - Exceptions to Tax on Early Distributions.”

  7. Internal Revenue Service. “401(k) Plan Overview.”

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