Tapping into a 401K Money Before Retirement
The consensus opinion among economists, public policy wonks and politicians is that income taxes will increase on January 01, 2011, if not sooner. Beginning in 2010 the income limit to convert qualified retirement money to a Roth IRA will be suspended allowing business owners, executives, doctors, attorneys and other high income professionals to capitalize on the tax and estate benefits of Roth IRAs.
The current volatility of the stock and bond markets, combined with uncertain economic times and a potentially explosive geopolitical situation, have many in the red zone of retirement concerned about losses on their retirement money. Many retirement-minded 401(k) plan participants live in fear of a market meltdown and/or a broad-based increase in taxes; either could eliminate or postpone retirement.
Even though ERISA has liberal rules allowing the transfer of money tax-free from retirement plans into self-directed IRAs and Roth IRAs, only the Fortune 1000 employers appear to have taken full advantage. For the smaller businesses and professional partnerships, there is a cost-free, painless way to self-direct retirement money now in 401(k), 403(b), 457 and other plans without sacrificing benefits.
Any employee, owner or a professional associate, regardless
of age,
participating in an employer-sponsored retirement plan, is permitted
to transfer their employer’s profit sharing/matching contributions
without terminating their employment, retiring or incurring a qualifying
hardship. Plus, any money previously moved to their current plan, as
well as the earnings can also be transferred to a self-directed IRA
tax-free and without sacrificing benefits. What’s more, continued participation
in the plan is permitted.
Anyone over age 59½ is permitted to transfer their employee contributions from a plan into a self-directed IRA without triggering a taxable event and without stopping plan participation.
The numerous advantages to employees and owners that wish to move their 401(k) money to investments and savings options totally under their control include:
- Immunizing retirement money from market meltdowns such as occurred in 2000-02 and 1973-74;
- Paying taxes on tax-deferred money before income tax and capital gains rates rise;
- Positioning qualified retirement money for conversion to a Roth IRA when the income limit is suspended in 2010;
- Reducing management and administrative fees now paid as a plan participant;
- Locking in current gains in retirement accounts;
- Better diversification of investment risks;
- Improved estate planning and much more.
To permit the transfer of moneys from an employer-sponsored retirement plan outside of the traditional events (retirement, disability, termination, hardship, etc.), it is necessary to add an “in-service, non-hardship withdrawal provision” to the plan. This change is cost-free and can be quickly implemented by the administrator of the plan; however, they, along with the broker and brokerage firm managing the money of the plan, can be expected to object to adding the in-service withdrawal provision. The broker and money management firm of the 401(k) plan will lose commissions and fees as the plan’s assets are transferred; thus, expect them to object to adding in-service withdrawal options. Oftentimes the plan administrator has a cozy relationship with the broker and brokerage firm and depends on them for future business; thus, they may be reluctant to recommend an in-service withdrawal provision. Nonetheless, in-service withdrawals are oftentimes in the best interest of employees and employers.
To confirm the ease and lack of costs associated with adding an in-service withdrawal provision to a 401(k) plan, the authors made the necessary changes in their employer’s plan. Adding the in-service withdrawal provision involved calling the third party administrator and making decisions regarding age, vesting, length of service and effective date. The benefits of adding the in-service withdrawal provision are tremendous while the limitations are minor. The steps needed to add the in-service provision to your plan is provided in “Appendix A”.
Shelby J. Smith, Ph.D.
Whet Smith, J.D.
June 2008
(revised September 2008)