What is an In-Service Rollover?

A 401(k) is an employer-sponsored retirement plan that generally allows contributions to be made pre-tax and grown on a tax deferred basis.¹ Employees do not pay taxes until they withdraw their money. In many 401(k) plans, employers match employee contributions up to a certain percentage or may make other employer contributions.

One potential limitation of some 401(k) plans is that they may only offer a handful of investment options.

• Americans held $7.3 trillion in 401(k) plans in 2021.
• Mutual funds managed $4.8 trillion, or 65% of assets held in these plans.
• Equity funds were the most common type of funds with $2.8 trillion invested, followed by $1.3 trillion in hybrid funds, which include target date funds.

ICI quarterly retirement market data, September 2021

For some employees, protecting a portion of their savings from market downturns while still growing their portfolios is a priority. Many 401(k) plans offer fund options that can provide lower risk than equities, but often do so at the expense of growth potential. Employees facing this challenge may want to consider an in-service rollover, an option allowed by more than 70% of employer plans.¹

How an In-Service Rollover Works

An in-service rollover allows employees to rollover a portion of their current employer-sponsored retirement plan account into a rollover individual retirement account (IRA). While rollovers are typically completed when an employee leaves a job, an in-service rollover enables the individual to move money without a job change. This type of rollover may benefit those seeking more investment choices and product features such as insurance guarantees.

How are In-Service Rollovers Taxed?

A Direct Rollover occurs tax-free when the money is rolled over directly from the 401(k) plan to a new or existing IRA. An Indirect Rollover occurs when the money is sent directly to the account holder. The owner must deposit 100% of the funds into a qualified retirement plan or IRA within 60 days to avoid paying income tax and penalties. Even though the distribution may have taxes withheld (typically 20%), the full gross distribution amount must be deposited to an IRA or qualified plan within the 60-day window. If the rollover is completed within the 60-day time limit, the contribution made to cover the withholding will be credited on the owner’s tax return.

What is the significance of age 59½ when it comes to in-service rollovers?

Generally, that is the age when many 401(k) plans permit in-service rollovers for currently working employees. Age 59 ½ is also the age at which the 10% early withdrawal penalty no longer applies. Some plans may have more restrictive rules or may not allow in-service rollovers.

Considerations

It is important to note that rollover rules are different for each employer plan. Employees should review their employer’s Summary Plan Description as well as talk with their financial and tax professional prior to effecting an in-service rollover to determine if it is right for their needs and circumstances. A rollover may result in higher total investment expenses, may not provide the same bankruptcy protections, and may affect the ability to contribute to the company’s 401(k) plan for a period of time. An in-service rollover may not be appropriate for every individual and circumstance.

Want to learn more about in-service 401(k) rollovers? Talk to your financial professional today.