Monday, May 17, 2010

In-Service Distributions

Many people work for employers who offer a less-than-desirable 401(k) plan. Unfortunately, many 401(k) plans offer only a limited number of investment options, which prevents plan participants from diversifying their retirement account. Additionally, a 401(k) may offer only investments with average to poor performance track records. Finally, some 401(k) plans only offer investment options with high annual expenses. Are employees of companies offering inferior plans simply out of luck?

Employers and 401(k) plan administrators don't advertise this fact, but most workers 59 and a half and older can roll over 401(k) funds into an IRA while they're still employed and contributing to the plan. This process is called an "in-service" distribution. This maneuver allows employees to roll their 401(k) funds into an IRA, where they have more control of their investments and access to better investment options, and still contribute to their employer's 401(k) and receive a company match. Alternatively, this process allows employees to take cash out of their plan while still employed, pay the ordinary income taxes due, and spend what's left.

The law allows this, but employers don't have to permit it. Still, 70% of companies -- and 89% of those with 5,000 or more employees -- allow these in-service withdrawals. In-service withdrawals can also be made out of 457 plans, 403(b) plans, and other retirement accounts.

Another potential advantage of taking an in-service withdrawal is that the funds can immediately be converted into a Roth IRA, where future earnings will be tax free. Yet another reason to consider an in-service distribution is if you're planning on leaving retirement money to your kids or grand kids instead of to a spouse. Under a 2006 law chance, kids and other non-spousal heirs can roll 401(k) s into inherited IRAs where withdrawals and tax deferral can be stretched out for decades, but only if the employer permits it, which not all do. To avoid any issues, get the money out now and put it into an IRA that won't have any employer getting in the way of your family's needs.

No comments: