DEFINITION of 'In-Service Withdrawal'

In-service withdrawals are made from qualified employer-sponsored retirement plans such as 401(k) plans before participants experience a triggering event. These events generally include reaching age 59 1/2, being terminated from employment, becoming disabled, or death. However, certain tax penalties may be levied on the amount withdrawn depending on the specifics of the distribution.  

BREAKING DOWN 'In-Service Withdrawal'

In-service withdrawals can be made in the form of hardship withdrawals if the plan allows it. The IRS permits plans to make hardship distributions when a participant displays an "immediate and heavy financial need." 

Employees are automatically considered to have an immediate need if they require the money to cover certain medical care expenses, educational costs and payments needed to prevent eviction from a principal residence, as well as other conditions deemed necessary for hardship distributions by the IRS.

A plan can allow a hardship withdrawal only after the employee has exhausted all other distributions or nontaxable loans available under the plan.  

Under IRS regulations, hardship distributions from a 401(k) plan are limited to an employee's elective contributions. The income these contributions accumulate generally can't be taken as a hardship withdrawal. If the plan allows, the employer's matching and discretionary contributions can be factored into a hardship distribution. 

However, the total amount withdrawn can't exceed what is necessary to cover the immediate financial need as well as any applicable penalties and taxes. Employees would also not be allowed to make deferrals to their plans within six months after receiving the hardship distribution.

Tax Implications of In-Service Withdrawals 

Most withdrawals made from a qualified employer-sponsored retirement plan before reaching age 59 1/2 will come with a 10% early penalty tax on the amount being distributed along with applicable federal income and state taxes. For example, say a 45-year-old individual is granted a hardship withdrawal from his 401(K) plan to help cover a $1,000 medical expense. The early withdrawal penalty alone would chip away $300 leaving him with only $700. He would also be liable for any 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

In addition to hardship distributions, individuals can take other types of in-service withdrawals from their employer-sponsored retirement plans while still employed with the company sponsoring the plan, and before breaching a triggering event. For example, non-safe harbor employer matching contributions and profit-sharing contributions can be distributed at any age. 

An individual can also withdrawal voluntary contributions at any time. Some plans allow employees to make these after-tax contributions in order for workers to boost nest eggs and secure certain tax benefits. 

Overall, however, the types and treatment of each eligible in-service distribution would be outlined in the summary plan description or the plan document itself. Specific tax details are set by the IRS. 

RELATED TERMS
  1. Withdrawal Benefits

    Withdrawal benefits refer to the rights of employees with retirement ...
  2. Withdrawal Plan

    A withdrawal plan is a financial plan that allows a shareholder ...
  3. Withdrawal

    A withdrawal is removal of funds from an account, plan, pension ...
  4. Matching Contribution

    A matching contribution is a type of contribution an employer ...
  5. 401(k) Plan

    A 401(k) plan is an employer-sponsored retirement account that ...
  6. Excess Accumulation Penalty

    Excess accumulation penalty is due the IRS when a retirement ...
Related Articles
  1. Taxes

    How 401(k) Withdrawals Work When You're Unemployed

    Unemployed individuals can pursue several options when taking money out of their 401(k), but they should carefully weigh taxes and possible penalties.
  2. Financial Advisor

    Tough Times: Should You Dip Into Your Qualified Plan?

    401(k)s, pensions and profit-sharing plans can be a source of cash, but there are consequences to this option.
  3. Retirement

    The Basics of a 401(k) Retirement Plan

    This plan has become one of the most popular retirement options. Here's why.
  4. Financial Advisor

    When to Consider an In-Service 401(k) Withdrawal

    In many cases, early withdrawals from 401(k)s to be avoided. But if you are 59 1/2 or older, they may help you devise a better retirement strategy.
  5. Retirement

    The Cost of Tapping Your Retirement Accounts Early

    It only makes sense in some situations to tap into retirement accounts early as a last resort.
  6. Retirement

    Your 401(k): Not the Best Emergency Fund

    If you have an emergency and need to access your retirement funds, you may have to pay a penalty if you dip into your 401(k). But there is a better option.
  7. Retirement

    Retirement Savings Tools I: Employer Savings Plans

    There are a variety of employer savings plans that can offer multiple routes to saving for retirement.
  8. Retirement

    How Yearly Taxes on 401(k) Accounts Work

    Learn how your contributions to traditional or Roth 401(k) accounts are taxed, either in the year of contributions or at withdrawal, depending on the type.
  9. Retirement

    Can You Afford To Retire Early?

    Early retirement is the hope of many people currently in the workplace. So, how do we get there - and what are the downsides?
Hot Definitions
  1. Monero

    Monero is a digital currency that offers a high level of anonymity for users and their online transactions.
  2. Risk Tolerance

    Risk tolerance is the degree of variability in investment returns that an individual is willing to withstand.
  3. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  4. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  5. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  6. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
Trading Center