Many readers of this column are aware that distributions from their retirement plans require a triggering event such as changing companies or retirement. It’s also pretty widely known that cash distributions made prior to age 59½ are typically subject to income tax plus an additional 10% penalty tax for early distribution.
However, it is less widely known that rules allowing access to retirement accounts over the decades have evolved. In many cases now, investors can access their employer plan retirement funds while employed via an “in-service distribution,” which is another way of saying plan participants can elect to roll over their assets to an Individual Retirement Account (IRA) while still employed, making new contributions to their 401(k) and receiving employer matching.
In-service distributions are complex, so it’s important to be familiar with the rules in order to avoid making costly errors. Employers are not required to offer in-service distributions. Rather, it’s an optional plan provision, so just determining when an in-service distribution option might be available is probably the first step for most investors. That being said, more than 70% of 401(k) plans now allow in-service distributions, and we have entered a period in world investment markets where we believe that many risk management tools not typically found in 401(k)’s are of heightened importance. So, it’s a good time to look into it.
One of the biggest reasons pre-retirees opt for an in-service distribution is investment flexibility. While participants in 401(k)s are allowed certain choices within their respective plans, investors typically have a much broader gamut of choices in their own IRA’s. For example, there may be fixed income funds within a 401(k), but ownership of individual bonds is not typically available. (We discussed in a recent Insights note why it’s often preferable to own the bonds.) Additionally, many non-correlative assets like commodities, structured notes and inverse ETF’s can be owned in an IRA but not in a 401(k).
In this day and age, not only with heightened market volatility but also this environment where many investment firms offer free IRA’s and even free transactions, we just feel like in-service distributions are worth a look. Besides opening up a whole new universe of potential investment vehicles and risk management strategies, in many cases, an IRA may actually be a lower cost option that one’s 401(k). In other words, retirement planning, much like the rest of our current day-to-day circumstances, has been turned on its head.
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