Can You Withdraw Your Retirement Plan Savings Without Leaving Your Job?
Learn About In Service Distributions
Workplace retirement plans are designed to prepare employees for . . . retirement. Salary deductions and employer money deposited into a 401(k) plan account over your working years are meant to appreciate over time with a combination of deposits and investment earnings. In an ideal world, your retirement plan account will remain intact until the time you elect to leave the workforce.
In reality, one of two things may happen while you are still actively employed:
- 1. You may encounter an event that triggers a financial need not readily resolved with ordinary income. Because the value of your 401(k) account is often greater than the value of your disposable income, one of the first places you may be inclined to turn to for financial resources is your company retirement plan.
- 2. You may arrive at an age when a customized investment portfolio in an IRA will be more attractive than the mutual fund menu offered in your company’s retirement plan.
But, can you withdraw your retirement plan savings without leaving your job? It depends.
401(k) plans are subject to IRS regulations that permit certain things and prohibit other things. An employer sponsoring a retirement plan may choose to be more restrictive than the IRS when it comes to withdrawing funds during your working years, but they cannot be more liberal. If the IRS doesn’t allow something, it isn’t allowed. If the retirement plan sponsor imposes further restrictions, even less is allowed.
Your first point of reference if you wish to withdraw funds from your employer’s retirement plan is the “Summary Plan Description,” which is a document provided to you by your employer when you become eligible to participate in the plan. If you have misplaced your copy of the Summary Plan Description, obtain a copy from your employer. An overview of your “In-Service Distribution” options are provided in that document.
If you have not attained age 59 ½
You will find your in-service withdrawal options will be limited prior to attaining age 59 ½.
- Some 401(k) plans offer loans. Others do not. A retirement plan loan permits you to borrow against 50% of your vested account balance, with a $50,000 loan limit. A loan is not a taxable withdrawal as long as appropriate administrative procedures are followed. Under a legally enforceable agreement, the loan is repaid through payroll withholding and your retirement account is eventually restored. Failure to pay the loan in full results in a taxable event.
- Some 401(k) plans permit “Hardship” distributions. Others do not. A qualifying “Hardship” is limited by the IRS to a narrowly defined list of eligible circumstances. Those limits will be defined in the Summary Plan Description. You will be required to provide your employer with documentation supporting the reason for your request, and the dollar value of your withdrawal. Because the proceeds are intended to assist you with a financial hurdle, a Hardship distribution is not eligible to be rolled into an IRA.
- You may not withdraw pre-tax salary deferrals, Roth deferrals, or employer “safe harbor” contributions prior to attaining age 59 ½ unless the Hardship rules offered by your plan permit it. Special tax rules apply to distributions of Roth contributions prior to your attainment of age 59 ½.
- If you have rolled money into your current employer’s retirement plan from a previous employer, you may have free access to those funds in a time of need. Again, the plan’s provisions will prevail.
If you have not yet attained age 59 ½, the IRS imposes an early withdrawal penalty of 10% of the value of your retirement account withdrawal. The 10% penalty is an addition to the flat 20% withheld at the time of distribution, plus any applicable state taxes applied at the time of distribution.
The 20% federal withholding is the IRS’s way of ensuring you cover the bulk of your federal tax liability. Your actual income tax withholding rate will be applied when your cash distribution is added to all other ordinary income for the year. With any luck, you may receive a small refund.
If you have attained age 59 ½
- Generally speaking, if you have attained age 59 ½ you may be able to access your entire account balance. By the time you have attained age 59 ½, the mutual fund offerings in the plan may no longer meet your investment objectives. The IRS considers 59 ½ to be a legitimate age for an actively employed individual to roll their funds into an IRA. A rollover to an IRA retains its tax-deferred status.
- At age 59 ½ you may be eligible to withdraw a portion of your account to cover a financial need of any color. The 10% early withdrawal penalty will not apply, and there is no requirement that you provide your employer with the reason for your distribution other than the fact that you have attained age 59 ½.
- A cash distribution will be subject to a flat 20% withholding rate. It is possible that state taxes will also apply, but it all comes out in the wash when you file your personal income taxes for the year of your distribution.
If you have ownership in the company sponsoring the retirement plan If you are the owner of the business sponsoring the retirement plan, you enjoy the tax advantages that go along with being both employer and employee. You are also both a plan fiduciary and an employee. As such, you are subject to stricter IRS guidelines when it comes to withdrawing funds from your company retirement plan.
- If you choose to take advantage of the plan’s loan allowance, you are subject to the same rules that apply to your common-law employees. But wait, there’s more.
- As long as loan payments are structured and paid with regularity, you are in good standing. But if your loan goes into default, you place the tax qualified status of the whole retirement plan at risk and the loan will be viewed as a “prohibited transaction” by the IRS. In addition to entering into a costly enforcement program, you will be required to return the borrowed funds to the plan in full, and pay an excise tax to the IRS.
- If you attain age 70 ½ and you are still actively participating in the business, you will be required to begin taking annual, taxable distributions from your retirement plan account. While your common-law employees can wait until they retire before taking Required Minimum Distributions (RMDs), you do not have that option. Furthermore, you may not aggregate the value of the annual RMD from your company’s retirement plan with any other retirement plans or IRAs. The RMD applies specifically to the retirement plan you sponsor, and the funds must be withdrawn from that retirement plan.
When it comes to withdrawing funds from your company retirement plan while you are actively employed, you will need to research what your 401(k) plan permits and what it does not. The Summary Plan Description will serve as a guide. Your company’s retirement plan administrator will be able to further assist with any required paperwork, and paperwork will be required. Also be aware that your company employs a Third Party Administrator with expertise in IRS regulations that apply to retirement plans in general, and the specifics that apply to your plan. For better or for worse though, the government and your employer want to ensure that your retirement savings are protected until you retire . . . and with due diligence, retirement will happen.
This information is meant as a reference point and general information. We understand that the Retirement Plan of your company is a small piece of your benefits package and do not expect you to be experts in this information. Whenever in doubt as to what is allowed and what can be done specifically within your plan provisions, do not hesitate to reach out to your assigned Benefit Consultant as this is why we are here. We are always happy to discuss any scenario that arises and advise you on the options available.