Could a 401(k) In-Service Distribution Work for You?

401(k) is spelled out in children's blocks sitting on top of cash and coins.

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By John Conley, Investment Adviser Representative

published 26 October 2023

Properly implemented, an in-service distribution could be a worthwhile money move to consider, allowing you financial flexibility rarely associated with most retirement accounts. But how do you know if this financial strategy is right for you?

What is an in-service distribution?

An in-service distribution allows an employee with a company-sponsored 401(k) plan to make a withdrawal or rollover from that plan while they are still employed by that company. The specific rules and eligibility surrounding an in-service distribution can vary depending on the retirement plan and the employer’s policies, but most 401(k) retirement accounts don’t allow early withdrawals until age 59½. It’s around this age that most people are coming down the home stretch toward retirement.

401(k) limitations

Most 401(k) accounts don't have individual stock positions, and the investment choices offered are often geared toward the average investor and younger employees, which means your investment options are limited.

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A target-date fund is a popular choice among employees for their 401(k) account. These funds are a set-it-and-forget-it approach to investing, containing a select group of stocks, bonds and mutual funds designed to manage risk while helping you grow your savings based on your retirement timeline. The portfolio automatically rebalances for risk according to your predetermined retirement date.

If you have a specific investment option outside of your retirement account that you believe will generate higher returns than your current retirement plan options, an in-service distribution can allow you to capitalize on that opportunity.

Diversification of assets

If a significant portion of your retirement savings is tied up in an employer-sponsored plan, an in-service distribution can enable you to invest in other asset classes or financial instruments, reducing the risk associated with having all of your eggs tied up in one basket.

Employees gain the freedom to explore a wide range of investment options that might not be available within their current retirement plan. This newfound flexibility can be especially beneficial for those with unique circumstances or specific financial goals. The world is your oyster!

For example, while many 401(k)s predominantly offer mutual funds, which may carry hidden costs and fees, an IRA allows you to invest in individual stocks, exchange-traded funds (ETFs) with low expense ratios, bonds and other tax-free growth positions. Investing becomes more accessible, putting the individual in control of their financial future.

Tax implications

While emergency withdrawals from a 401(k) are usually allowed, rolling over funds through an in-service distribution eliminates the ability to take a loan from that IRA.

Despite the potential benefits, it’s essential to exercise caution before opting for an in-service distribution. Consider tax implications, early withdrawal penalties and the impact on your long-term retirement plans.

Consult with a financial adviser to assess the suitability of an in-service distribution based on your specific circumstances and financial goals.

Risk tolerance

Many people are not fully aware of their risk tolerance and may base their choices solely on past returns. This is where the expertise of a financial adviser becomes invaluable. A skilled adviser can help individuals assess their risk tolerance accurately, align their investments accordingly and ensure their portfolio is adequately diversified.

An in-service distribution allows individuals to diversify their holdings and reduce exposure to the potential failure of any one company. Many companies now offer this option, and employees should seize the opportunity to diversify their investment holdings.

By exploring investment options beyond the confines of a 401(k), individuals can make well-informed choices that align with their unique financial circumstances. Consulting a financial adviser is a wise step toward creating a comprehensive plan and making the most of the opportunities provided by an in-service distribution.

Remember, knowledge is key, and seeking out options like an in-service distribution can make a difference in securing your financial freedom in retirement.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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John Conley has more than 25 years of experience in the financial industry. As a fiduciary adviser at Rubino & Liang Wealth Partners, John helps his clients with retirement planning, asset accumulation, college funding and retirement income solutions. He holds Series 6, 63 and 65 licenses and is a registered life adviser in MA, NH, RI and FL. Before entering the financial industry, John served in the United States Marine Corps from 1990-1994 and achieved the rank of corporal non-commissioned officer.