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Understanding
In-Service Distributions
Many individuals believe they cannot
take control of their retirement plan assets until
retirement (usually age 65), or at least not until they
leave employment. We know from experience that this
simply is not the case. IRS distribution regulations,
greatly liberalized over the past 30 years, permit
“in-service distribution” opportunities for working
participants. An in-service distribution option allows
certain plan participants to access some or all of their
retirement assets while they are still employed and, if
appropriate, invest them in IRAs, which may allow for
greater diversification. Through our document review
service, offered through the Columbia Management
Resource Desk, our ERISA consultants have reviewed
thousands of employer plan documents and have documented
a high percentage of plans that give participants access
to these in-service distribution provisions.
When to Consider an In-Service
Distribution
There are many reasons why plan
sponsors adopt in-service distribution provisions for
their participants, including providing an attractive
feature in an employee benefit package, making the plan
more amenable to participants interested in a phased
approach to retirement, and allowing for increased
participant control of assets.
Plan participants may find an
in-service distribution option appealing because they
gain control of their retirement assets as well as the
potential for more flexible investment strategies and
improved service through “open architecture” rollover
IRAs. Keep in mind
that a rollover may not be right for everyone. We
have found that participants whose perceived level of
investment diversity, or whose advice and service inside
their 401(k) plans is low, may be likely candidates to
consider an in-service rollover. Another key
consideration is fees. It is important to understand and
compare relative fee levels available inside the plan
vs. within the IRA when considering an in-service
rollover. Fees are an important aspect to consider in
any investment decision, and this is no exception.
Types
of In-Service Distributions
There are several types of in-service
distributions, including age-based, source-based,
class-based and hardship. Each is explained below.
·
Age-based in-service distributions are tied to the
participant’s attainment of a plan-specified age, such
as 59˝ or an early retirement age.
·
A
source-based in-service distribution option allows
participants access to their assets based on type of
contribution (e.g., rollover dollars, employer match
and/or employee after-tax). These dollars, if eligible,
do not require a participant to attain a certain age.
They can, however, be restricted to only those
participants who have satisfied a specific service
requirement.
·
There
is a newly developed class-based in-service provision
for military personnel and their families. Effective
January 1, 2009, the Heroes Earnings Assistance and
Relief Act of 2008 allows individuals on active duty in
the uniformed services for at least 30 days who are
still employed to take an in-service distribution of
their elective deferrals or after-tax contributions
under a 401(k), 403(b) or 457(b) plan, if the plan
document permits.
·
Plans
that offer hardship distributions must limit them to
situations where a participant can demonstrate an
immediate and heavy financial need, and only a hardship
distribution can satisfy such need.
Note: In-service distributions due to hardship are not eligible for
rollover.
It
All Starts with the Plan Document
The first step in determining
in-service distribution availability is to examine the
governing employer-level plan documents. The plan
document will specify whether an in-service distribution
provision is available, the conditions under which the
working participant may use the in-service distribution
option, what types of dollars are available, and any
consequences of taking an in-service distribution.
Painstakingly reviewing voluminous plan documents for
in-service distribution provisions can be an unpleasant,
time-consuming chore. We’ve developed a thorough,
scalable process, which is available to financial
advisors through the Columbia Management Resource Desk.
Other
In-Service Distribution Insights
Other considerations to keep in mind
when discussing in-service distribution options include
the following.
·
Employee after-tax contributions in qualified plans are
eligible for rollover to an IRA. This was not true prior
to January 1, 2002.
·
Beginning in 2007, defined benefit plan participants who
have reached age 62 may be eligible for in-service
distributions. Check the plan document for a newly added
amendment.
·
Taking employer contributions through an in-service
distribution can, in some instances, trigger a
suspension of the employer match. Read the plan’s fine
print carefully.
·
In-service distributions are includible in taxable
income and potentially subject to an early distribution
penalty if the amount is taken prior to age 59˝ and no
penalty exception applies, or if they are not properly
rolled over to another eligible plan. The distribution
recipient must be aware that if he or she is not age
59˝, or not rolling the distribution into an IRA or
other retirement plan, he or she could be subject to
taxation and an additional 10% early-distribution
penalty tax.
Conclusion
The option to take in-service
distributions from a 401(k) plan can be an important
financial planning consideration for individuals—one
that often goes unnoticed. Financial advisors can play
an invaluable role in helping participants determine
whether an in-service distribution is possible, and
whether a subsequent rollover would be in their best
interest. Working with the Columbia Management Resource
Desk can streamline the process for making these
determinations.
The Columbia Management Learning Center®
The Columbia Management Learning
Center is a dedicated resource offering thought
leadership in financial planning and retirement
strategies. From regulatory and legislative issues to
demographic and economic trends, we are committed to
providing financial advisors and their clients with the
latest research and most innovative financial solutions.
Advisors
who want to take advantage of the Columbia Management
Learning Center may contact a Columbia Management
Regional Sales Consultant at 877.894.3592
This material is for educational purposes only. It
cannot be used for the purposes of avoiding penalties
and taxes. Columbia Management does not provide tax or
legal advice. Please consult a tax or legal advisor for
individual needs.
Columbia Management Group, LLC (“Columbia Management”)
is the investment management division of Bank of America
Corporation. Columbia Management entities furnish
investment management services and products for
institutional and individual investors.
The Columbia Management Resource Desk is staffed by the
Retirement Learning Center, a third-party industry
consultant that is not affiliated with Columbia
Management or any other Bank of America affiliate. Any
information provided is for informational purposes only.
Please consult a tax advisor or attorney for specific
tax or legal needs.
CRS-28/16008-0509
09/AR81854
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