What is an In-Service Distribution?

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If you need to get money out of a 401k plan, you need to know about in-service distributions. Generally, there are two types of in-service distributions:

  1. Hardship, in-service distributions
  2. Non-hardship, in-service distributions

Hardship in-service distributions are relatively well known and widely available from 401k accounts. This is the type of distribution you take when experiencing financial hardship, often related to illness or natural disaster.

However, there are lesser known non-hardship distributions. In-service distributions allow you to move employer controlled 401k funds. If allowed, you can move money into a self-controlled Solo 401k account while still working for the original employer. These distributions are “in-service” meaning you are still employed by the company you’re removing 401k funds from.

Safe Harbor for Hardship, In-service Distributions

IRS regulations provide a “safe harbor” that automatically enables an employee to access 401k funds for an immediate and heavy financial need. Generally, you can take a  distribution for any of these uses:

  • Medical care expenses for the employee, the employee’s spouse, dependents, or beneficiary.
  • Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
  • Tuition, related educational fees, and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents, or beneficiary.
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
  • Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary.
  • Certain expenses to repair damage to the employee’s principal residence.

Unless the funds are Roth contributions, hardship distributions are subject to income taxes. Additionally, they may be subject to a 10% penalty (if under age 59 ½).

The 2020 CARES Act did make exceptions for COVID-19 related hardship distributions. Those distribution provisions expired on December 31, 2020.

What is a Non-Hardship In-Service Distribution?

Also known as a “Non-Hardship Withdrawal” or simply “in-service distribution”. This is any time that you withdraw funds early from a 401k account with the possibility of triggering taxes and the early withdrawal penalty. But there is a simple process that doesn’t have to trigger the taxes and penalty.

A non-hardship, in-service distribution does not involve one of the events listed as a hardship withdrawal. Sometimes you can take this distribution while still being “in-service” to your current employer.  Typically the 401k plan administrator will cut a check to you personally for the distribution.

If you move the funds to your Solo 401k account within 60 days, you can avoid paying the taxes and penalty. If you fail to complete the transfer within 60 days, you may owe the taxes and if you are under age 59 ½ you will owe the penalty for early withdrawal.

Indirect Rollovers into a Solo 401k Plan

Depositing funds into a retirement plan from a rollover check paid to you personally is an indirect rollover.  Sometimes an indirect rollover is called a 60-day rollover. An indirect rollover is when you have access to the funds (personally) for up to 60 days. This is different from a transfer, which is when the custodian of the previous account directly transfers the funds to your Solo 401k without you ever having access to the funds. Keep in mind you may trigger possible tax and penalty consequences. Remember, you only have 60 days to deposit the funds into your Solo 401k. This includes weekends and holidays. The IRS does allow some exceptions to the 60-day rule, but they are not common.

With an indirect rollover, the releasing custodian sometimes (but not always) withholds 20% of the transfer amount. The plan administrator withholds this amount to pay the taxes due on the distribution. When you complete the rollover, the IRS returns your money as a tax credit. To obtain that tax credit, you’ll need to use other funds to make up the 20% withheld. You also have to document the indirect rollover with the IRS.

For full clarity, there is another version of a non-hardship, in-service distribution. This would be if you withdraw the funds but have no intention of rolling them over into another qualified retirement account. Maybe you decide to buy a boat or vacation home. In that case, you will owe all of the taxes and the early withdrawal penalty if you are not over age 59 ½.

Why You Don’t Know About Non-Hardship, In-Service Distributions

Some (but not all) employers allow non-hardship, in-service withdrawals without retirement or job termination.

Employers that allow non-hardship, in-service withdrawals often have their own policies and guidelines on when you are eligible for the distribution. You can usually learn what these are by reading your employer’s 401k FAQ, reading the Summary Plan Description, or talking directly with the program administrator. Requirements might be spouse approval, a minimum withdrawal, or something else specific to your employer.

In-service distributions aren’t common because employers prefer to keep access to your retirement funds as long as possible. There are many reasons for this but a couple are as simple as the more money they have under their control, the more leverage they have when making investments and to collect interest payments on cash reserves. Still, it’s worth asking if you have access to your own money. Especially if you plan to invest in alternative assets through a Solo 401k, or simply want control of your own retirement funds.

Advantages You Gain from Non-Hardship, In-Service Withdrawals

By putting money in your Solo 401k through an in-service distribution you gain full control of your retirement funds. Instantly, you’ll be able to invest in what you want rather than being limited to the choices offered by an employer’s account. Employer accounts often have strict restrictions. You can avoid these restrictions by using a non-hardship, in-service distribution and putting those funds in your Solo 401k. You also gain greater freedom to plan your future investments rather than being bound to your employer’s future decisions.

The purpose of this process is not to stop you from continuing to add to your employer-sponsored 401k. It makes good financial sense to continue building your retirement by collecting your employer’s contributions. However, this might be a time when you want to make some changes to gain full control over a substantial portion of your retirement funds. You probably have your own reasons but it could be because you feel behind, are worried about preserving your wealth, or to stretch your retirement income out as long as possible. Moving your funds to a Solo 401k can give you the control that you need.

What To Do Now

You can contact us to discuss your situation but often the first step is understanding how to make a non-hardship, in-service withdrawal from your employer’s retirement account. That might be a conversation with the plan administrator. The type of questions that you want answers to are:

  • Is a non-hardship, in-service withdrawal allowed?
  • What policy applies?
  • Are there any restrictions on the distribution?
  • What is the maximum or minimum distribution allowed?
  • How do they handle possible tax consequences?
  • Is there a timeline that needs to be followed?
  • What else should I know?

Nabers Group understands that you want full control of your retirement funds. A direct transfer is the safest way to rollover funds to your Solo 401k. However, that isn’t always possible. That’s where the in-service distribution comes in. We will gladly work with you when a non-hardship, in-service distribution best fits your financial strategy and needs.

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