Understanding In-Service Withdrawals: What Employers and Employees Need to Know

When it comes to retirement plans, many participants assume they can't touch their funds until they leave their job or retire. However, in-service withdrawals offer an exception, allowing employees to take distributions from their retirement accounts while still employed. This flexibility can be appealing, but it also comes with rules and potential tax consequences that both employers and employees should understand [1] [2].

What Are In-Service Withdrawals?

In-service withdrawals are distributions from a retirement plan, such as a 401(k) or 403(b), that employees can take while they are still working for their employer [1]. Unlike regular distributions taken after retirement or job separation, in-service withdrawals allow access to retirement savings without leaving the company. These withdrawals can be particularly useful in situations like financial hardship, funding a large purchase, or taking advantage of investment opportunities [3].

"An in-service withdrawal is when you take money from your 403(b) while you still work for the employer that administers it. Most plans allow in-service withdrawals only after you reach age 59½." [2]

Plan Rules and Restrictions

Not all retirement plans offer in-service withdrawals, and those that do may have specific rules governing them. For instance, many plans restrict the types of contributions that can be withdrawn. Some plans may allow withdrawals only from certain sources, such as after-tax contributions or employer matches, while prohibiting access to pre-tax employee contributions [1] [4].

Additionally, there are age restrictions to consider. For most retirement plans, employees must be at least 59½ years old to take an in-service withdrawal without incurring a 10% early withdrawal penalty. However, there are exceptions, such as hardship withdrawals, where employees can access their funds earlier but may still face tax penalties [3] [4].

Tax Implications and Penalties

In-service withdrawals can trigger significant tax consequences. Unless the funds are rolled over into another qualified retirement plan or an IRA within 60 days, the withdrawal amount is typically subject to income tax. If the employee is under age 59½, the withdrawal may also be subject to a 10% early withdrawal penalty. This combination of taxes and penalties can significantly reduce the amount an employee takes home [1] [4].

For hardship withdrawals, while the 10% penalty may be waived, the withdrawal is still subject to income tax, making it an expensive option for accessing funds early. Employers should ensure that employees are fully aware of these implications before proceeding with an in-service withdrawal [3] [5].

"When you make a withdrawal from a standard 403(b) account, the amount distributed to you is taxed at your regular income tax rate. If you have a Roth 403(b) account, you won't owe any taxes because you'll have paid them in the year you contributed." [4]

The Role of Employers

Employers play a crucial role in managing in-service withdrawals. They must ensure their retirement plan documents clearly outline the availability and conditions of these withdrawals. Additionally, employers are responsible for educating employees about the potential risks and benefits, including tax implications and the impact on long-term retirement savings [1] [5].

In-service withdrawals can be a valuable tool for employees facing immediate financial needs, but they should be used with caution. Employers who provide clear guidance and support can help their employees make informed decisions that align with their long-term financial goals.

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References

 [1] Cerity Partners. (n.d.). In-Service Withdrawals from Employee Retirement Plans. Retrieved from https://ceritypartners.com/insights/in-service-withdrawals-from-employee-retirement-plans/ 

 [2] Empower. (2023, November 27). Unraveling the 403(b): Eligibility, withdrawal rules & taxes. Retrieved from https://www.empower.com/the-currency/work/403b-plan 

 [3] Internal Revenue Service. (2024, May 7). Retirement Plans FAQs regarding Hardship Distributions. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-hardship-distributions 

 [4] The Motley Fool. (2024, March 28). Rules for 403(b) Withdrawals in 2024. Retrieved from https://www.fool.com/retirement/plans/403b/withdrawal/ 

 [5] Internal Revenue Service. (n.d.). Retirement plans FAQs regarding 403(b) tax-sheltered annuity plans. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-403b-tax-sheltered-annuity-plans