Early Money

Using in-service distributions to generate business and build relationships

by Kevin Hedstrom

Although many employers and 401(k) plan administrators don’t actively promote it, most workers who are age 59 1/2 and older – along with many who are younger – are allowed by law to roll over a portion of their 401(k) funds into an Individual Retirement Account while they are still actively employed. This transaction is what’s known as an in-service withdrawal, or in-service distribution.

Typically, an in-service distribution can be made from a qualified plan without the account holder having to experience what is referred to as a “triggering event.”

• Death
• Disability
• Financial Hardship
• Separation of Service
• Age 59 ½

The in-service withdrawal provision allows proceeds to be directly rolled to another eligible retirement plan (Rollover IRA).  Therefore, the money is not subject to ordinary income tax nor a 10% federal tax penalty if taken before age 59½.

Taking Control of Retirement Funds Today

In certain instances, employees have been able to access their qualified retirement funds without being penalized by the IRS. For example, if the holder of a 401(k) plan had medical expenses that exceeded 7.5% of his or her annual adjusted gross income, they could make a penalty free withdrawal from the account.

With an in-service distribution, though, investors can also avoid the penalty – and the taxes. The key with in-service distributions is that the investor doesn’t have to demonstrate any type of specific need or hardship. But the person does have to be an active employee in order to pull from the employer-sponsored plan.

This is an area that currently isn’t all that well known or utilized among investors or financial services advisors – yet, it can offer a great deal of benefit and opportunity for both, starting with freedom and control of assets for investors, and a substantial growth in assets under management and avenue to generate more business for financial services reps.

In-Service Distribution Advantages for Clients

By rolling funds into a personal IRA account through an in-service distribution, clients will be able to create for themselves a great deal of control, freedom, and diversification in terms of the investment opportunities that are available to them. In some cases, company 401(k) plan offerings are less than stellar, so by moving out of the plan, an investor can open up a whole new world of choices.

In addition, unbeknownst to many employees, being part of an employer-sponsored retirement plan can actually be expensive. Some of the smaller plans can even have annual fees on domestic equity mutual funds that are in excess of 2% per year. With fees in that range, your savings would have to generate a fairly significant return just to break even.

Another reason investors may consider doing an in-service distribution is if they will be leaving retirement money to children or grandchildren rather than to their spouse. Spouses who inherit 401(k) or IRA money are allowed to roll the funds into their own IRA account. But non-spousal heirs such as kids or grandkids don’t have that option.

They can, however, keep the funds in what is known as an “inherited IRA.” This allows them to potentially stretch out their withdrawals – as well as their tax deferral – for many years into the future. This type of beneficiary distribution option is not available in most employer-sponsored plans – which may limit choices for beneficiaries.

Back in 2006, the law changed, allowing non-spousal beneficiaries to roll 401(k) funds into inherited IRA accounts – but only if employers permitted it. Not all employers do, so it is important to first find out if a client’s employer will allow the transaction to take place.

One of the bigger advantages of in-service distributions is the fact that they allow clients the ability to create a “personal pension”. This can be accomplished through utilizing a deferred annuity with an income rider. Defined benefit plans are literally disappearing rapidly, so by being able to reposition retirement assets into a vehicle that can provide guaranteed income down the road – creates peace of mind both before and throughout retirement.

Advisor Opportunities with In-Service Distributions

In addition to the many client advantages, in-service distributions also provide a number of benefits for financial advisors as well. First, many people aren’t even aware that this option is available to them, so this is a great opportunity to educate both clients and prospects about what they can do, and how it can benefit them.

Investors may be putting the majority of their retirement funds into a plan that provides poor options for the goals and objectives that they have – but because they don’t realize that they have another alternative, they essentially “throw good money after bad” and continue to take chances with their funds for the future – and that’s unfortunate.

Most clients who are either in or approaching retirement simply can’t afford another market correction. If their nest eggs take another hit like most did in 2008, they’re left with one of two options – either continue working, or live less of a lifestyle than they had originally hoped for in retirement. But with an in-service distribution provision, advisors have an opportunity to step in and reposition a portion of assets – potentially employing a fixed indexed annuity which will essentially put a stop-loss on clients’ assets with the downside protection offered through this type of contract.

In-service distributions can also provide a great way for advisors to gather assets. Oftentimes, clients who have been saving for many years in an employer-sponsored plan can have a substantial amount of money accumulated, especially when factoring in the tax-deferred growth and any employer matching employer contributions. Introducing this strategy to existing clientele as well as prospects can quickly increase an advisor’s assets under management.

Exploring All of the Angles

Just like with any other type of planning technique, it is important to explore all angles of whether or not an in-service distribution makes sense for a particular client, as there are some scenarios where it may make sense to leave the funds where they are.

For example, leaving a client’s retirement funds in an employer-sponsored 401(k) plan may be the better option for them if:

• Fees are low. While 401(k) fees are oftentimes high, there may be instances, such as with index funds, where fees could be lower in the 401(k) plan.
• The client is planning to retire early. Here, a person can make penalty-free withdrawals from a 401(k) plan as early as age 55, whereas with an IRA account, they would typically need to wait until they reached age 59 1/2 in order to do so.

Finding Success Using In-Service Distributions

When working with clients on in-service distributions, there are some things for advisors to keep in mind in order to ensure that things move smoothly. For example, it is important to check with the client’s plan administrator or the plan document in order to determine if the plan even allows in-service withdrawals. If it does, then it is also essential to determine what type of funds can be withdrawn. This is because most will allow only vested employer contributions to be moved.

When moving through the actual in-service distribution process, it is also a good idea to have the client be as hands on as possible, as this can often make things move faster – although the time frame can vary from one employer to another in terms of actually getting the funds transferred over.

The Bottom Line

While in-service distributions may not be right for all clients, this option could provide the ideal solution for many who are seeking more freedom and control in terms of where their retirement funds are invested.

Today, investors are looking for more attractive investment choices, along with better ways to leave money to heirs, or even a chance to move employer-sponsored retirement funds into a Roth IRA account.

An in-service distribution can allow clients more investment options, giving them much more freedom and control over their retirement funds. Because of this, these transactions can provide a great deal of opportunity for financial advisors who present the option to clients and prospects.

The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult with your attorney, accountant, and financial advisor or tax advisor prior to investing.

Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker/Dealer and member FINRA & SIPC. Futurity First Insurance Group is Independent of ProEquities, Inc.