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Is an In-Service 401k Distribution a Good Idea?

A reader writes in, asking:

“My employer’s 401k allows for in service distributions. I’ve read that it’s commonly a good idea to roll over a 401k after leaving your job, but I haven’t seen analysis for roll overs while still at your job. Is it basically the same decision?”

For readers who aren’t familiar with the concept of an “in-service distribution,” the basic idea is that 401(k) plans can (but are not required to) allow participants to roll their pre-tax contributions, Roth contributions, and employer match contributions over to an IRA after reaching reaching age 59.5, even while the participant is still an employee of the company.

Factors to Consider

When deciding whether or not to take an in-service distribution, the primary factors are very similar to those for considering whether or not to roll over a 401(k) from a previous employer.

  • If the investment costs in your 401(k) are higher than what you’d pay in an IRA (and they usually are), that’s a point in favor of moving the money.
  • If you have made nondeductible contributions to a traditional IRA, and you are planning to convert the traditional IRA (or part of it) to a Roth, you may want to hold off on any in-service distributions until the year after the conversion so as to minimize the portion of the conversion that’s taxable as income.
  • If there’s lawsuit pending against you (or you have reason to expect one in the future), you may want to keep the money in your employer’s plan to take advantage of the protection that such plans have against court judgements.

Additional Factor: No RMDs While Working

In addition to the above factors, you’ll also want to consider one factor in favor of keeping the money in your current 401(k): There are no minimum distribution requirements from a 401(k) plan while you’re still employed by the company, unless you’re an owner of the company with at least a 5% ownership interest.

The reason the lack of RMDs for employees doesn’t matter when considering regular (that is, not in-service) 401(k) rollovers is that if you’re considering a rollover, you must have already left the company, so there would be RMDs beginning at age 70.5, just as there would be with a traditional IRA.

Still, In-Service Distributions Are Often a Good Idea

As you might imagine, most people do not plan to continue working past age 70.5. And most people do not have any pending lawsuits. Nor are most people considering a Roth conversion of a nondeductible traditional IRA contribution. As a result, for people with the option to do so, it often makes sense to take an in-service distribution as a way to gain access to less expensive investment options.

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  1. Mike, I consider this an excellent idea that doesn’t seem to get much publicity. (It is nowhere mentioned, for example, in either of the Bogleheads books.) I did this two years ago with my 401(k) in Fidelity, moving most of my balances to my Vanguard IRA. At the time, Vanguard still had a $100K threshold for converting to Admiral shares, and this move let me increase my balances in several funds for this purpose. There is also the simplification advantage of consolidating your funds under one umbrella.

    But also there may be some restrictions even if the 401(k) allows an in-service withdrawal: “Taking an in-service distribution may affect your ability to contribute to your employer-sponsored plan.” ( Fortunately our plan had no such limitations, and now that I’ve got another two years of 401(k) contributions, I might do another in-service withdrawal in the near future.

  2. Another potential advantage in the 401(k) vs. IRA discussion is that by rolling your 401(k) money into an area you can take advantage of some additional beneficiary options that are not available with the 401(k).

  3. I meant “rolling your 401(k) money into an IRA . . .” not an area. Sorry.

  4. I did something a little different back in 2009. When the stock market was at its bottom and buying stock was like shooting fish in a barrel, I felt I could do much better in an IRA than the 401k was doing, so I borrowed the maximum IRA contribution (for 2 people for 2 years) from my 401k plan and invested it all into IRAs for me and my wife. That turned out to be a smart move, because the returns on my IRA dwarfed anything the 401k did.

    I also discovered that paying the interest to my 401k was a small additional over the limit addition to the 401k.

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