Should You Consider an In Service Distribution?
As a Registered Investment Adviser in the Jackson, Michigan area, we work side-by-side with many clients who are employed by companies like CMS Energy, Tenneco, Allegiance Health, and Jackson College (to name a few) that offer the possibility of in service distributions.
In case you are unfamiliar with the term in service distribution, let us quickly provide some background for you. Once you reach the age of 59 1/2, some companies allow their employees to rollover their vested balance in their retirement plans to an Individual Retirement Account (IRA) while continuing to fund their plan. By retirement plan, we mean a 401(k), 403(b), 457 and even pension funds just to name a few. Sounds pretty great, right? Well, like any other investment option, there are pros and cons to making this move.
Here are some reasons why you might want to consider making an in service distribution:
- MORE INVESTMENT OPTIONS – When you rollover to an IRA, you are leaving your limited retirement plan and gaining more control. IRAs have more investment options than most retirement plans including holdings like metals, commodities, individual stocks, etc. By rolling over to an IRA you can essentially free yourself from restrictions and allow yourself better diversification options.
- CASH FLOW – During these extremely volatile times, it’s certainly a perk to have the ability to create a stream of cash through dividend paying investments. Although some retirement plans have funds that pay dividends, most do not.
- STRETCH BENEFICIARIES – Usually IRAs allow non-spouse beneficiaries to “stretch” an inherited IRA over their lifetimes. This option is not available in most employer-sponsored plans, which may limit distribution choices for your beneficiaries.
- DISTRIBUTION OPTIONS -Whether or not you can take a distribution is all determined by your retirement plan document, so once again you are subject to your plan’s rules.
On the flip side, there are some disadvantages to making an in service distribution as well:
- “LOANS” – Some retirement plans allow you to borrow money from them; however, IRAs do not allow this.
- SEPARATION FROM SERVICE RULES – In qualified plans, the age 55 rule allows participants who stop working at age 55 or older to take distributions without the 10% IRS premature distribution penalty. In an IRA, you may take distributions before 59 ½, but it is certainly more cumbersome. In the case of the IRA you could utilize a 72(t) payment or substantial equal payments for five years or until 59 1/2 (whichever is greater) to avoid the 10% early withdrawal penalty. The IRA rules are somewhat complicated and generally better to avoid if possible; however, it can be done.
- NET UNREALIZED APPRECIATION (NUA) — Distributions from IRAs do not allow NUA tax treatment. If you hold highly appreciated company stock in your employer-sponsored plan, the rolling of that stock to an IRA eliminates any ability you may have to take advantage of NUA tax treatment.
- AFTER TAX MONEY — Qualified plans often separate after tax money so that it can be distributed separately. For example, no matter your age you would typically have access to your contributed after-tax dollars, subject to your plan rules of course. However, if you have after tax dollars in your work plan and unknowingly roll all of your funds (both pre-tax funds and after tax funds) into an IRA the “basis” or “after-tax” funds must now be distributed pro-rata as you pull money out of your IRA over your life. For simpler terms, let’s look at this like coffee and cream; once you mix cream (after-tax dollars) into your coffee (IRAs), it cannot be separated just as you cannot isolate the cream once mixed with the coffee.
With some great advantages and some very important disadvantages to consider, we highly recommend you talk with a qualified financial professional to determine your best option based on your goals and the tax implications involved; in addition, you should also check the rules on your company retirement plan prior to making any decisions. And of course, we would be happy to assist you with the in service distribution decision; just give us a call at 517-536-5000.
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