In-Service Withdrawals from 401(k) Plans For Target Employees

If you have previously worked for a company, you may be familiar with the regulations for contributing to a 401(k) plan. But are you conversant with the withdrawal regulations? Federal law restricts the available withdrawal options for 401(k) plans. On the other hand, a 401(k) plan might not give you as many withdrawal options as the law allows or might not allow you to take any money out until you leave Target. However, a lot of 401(k) plans offer greater flexibility.

More sixty-year-olds are opting to take in-service withdrawals from their 401(k) plans in order to pay off debt or cover unforeseen expenses, according to recent study by Fidelity Investments. Based on their data, a substantial increase from prior years occurred in 2020—nearly 1 in 5 60-year-olds withdrew from the workforce while still employed. Even while it's crucial to carefully assess the possible effects of such withdrawals on retirement savings, an in-service withdrawal can be a useful source of liquidity for people who are in dire need of money. (Source: In-Service Withdrawals from 401(k) Plans: What You Need to Know, Fidelity Investments, March 2021).

First, consider a plan loan

Numerous 401(k) plans permit you to obtain funds from your account. Clients of Target who do not qualify for a withdrawal, do not want to incur the taxes and penalties that may apply to a withdrawal, or do not want to irrevocably deplete their retirement assets may find a loan attractive. (You must also accept any available loans from all plans potentially maintained by Target before you can withdraw your own pretax or Roth contributions from a 401(k) plan due to hardship.)

In general, you may borrow up to $50,000, or half of your vested account balance (including your contributions, Target's prospective contributions, and earnings).

You may acquire the funds for a maximum of five years (or longer if the loan is for the purchase of your primary residence). In most cases, the loan is repaid via payroll deduction, with principal and interest being deposited back into your account. However, bear in mind that when you borrow, the unpaid principal of your loan is no longer contributing to your 401(k).

Withdrawing your own contributions

If you have made after-tax (non-Roth) contributions to your 401(k), you may withdraw those dollars (and any investment earnings on them) at any time and for any reason. You may only withdraw your pretax and Roth contributions (also known as 'elective deferrals') for one of the following reasons, and only if your plan specifically permits the withdrawal:

1. You attain age 59½

2. You become incapacable

3. It is a 'qualified reservist distribution'

4. You experience a hardship (also known as a 'hardship withdrawal')

Hardship withdrawals are only permitted if you have an urgent and substantial financial need, and only up to the amount required to meet that need. In the majority of programs, you must use the funds to:

1. Purchase or renovate your primary residence if it was damaged by an unforeseen event (e.g., a hurricane).

2. Avoid evictions and foreclosures

3. Pay medical expenses for yourself, your spouse, your children, or plan beneficiaries.

4. Pay specific funeral expenses for your parents, spouse, dependent children, or plan beneficiary.

5. Pay for certain education expenses for yourself, your spouse, your offspring, or a plan beneficiary.

6. Pay any income tax and/or penalties owed on the withdrawal itself.

With the exception of certain pre-1989 quantities that were grandfathered in, investment earnings are not available for hardship withdrawals.

In addition to the tax consequences described below, clients of Target should also consider the disadvantages associated with hardship withdrawals. You cannot take a hardship withdrawal until you have withdrawn all other funds and taken all nontaxable plan loans from all retirement plans that Target may potentially maintain. And, in the majority of 401(k) plans, the employer, such as Target, is required to suspend your participation in the plan for at least six months after the withdrawal, meaning you could lose out on potentially valuable Target matching contributions. Hardship withdrawals are not eligible for rollover. Therefore, Target employees should closely consider a hardship withdrawal before making one.

Withdrawing employer contributions

It can be much harder to get company contributions from a 401(k) plan. Certain plans do not allow you to take any employer contributions before your job ends, but others are more lenient and allow you to withdraw a minimum amount of vested employer contributions. 'Vested' contributions are non-refundable in any situation. Generally speaking, you may be able to withdraw vested corporate matching and profit-sharing contributions from a 401(k) plan if:

1. You become incapacable

2. Your employer has some discretion regarding the definition of hardship for this purpose.

3. You reach a certain age (for example, 59 12)

4. You have participated for at least five years, or

5. Generally, the employer contribution has been in the account for a minimum of two years.

Taxation

When you withdraw from your retirement plan, your own pretax contributions, company contributions, and investment earnings are subject to income tax. Contributions made after taxes will be exempt from taxation when withdrawn. Each withdrawal is presumed to include a proportional amount of taxable and nontaxable funds.

If your distribution is 'qualified,' it will be fully excluded from federal income tax. Your Roth contributions and the investment earnings on them are taxed separately. Each withdrawal that is deemed "nonqualified" will be handled as a proportionate distribution of your taxable investment gains and nontaxable Roth contributions. If a distribution is made after being disabled or after the age of 5912 and the five-year holding term is fulfilled, then the distribution is qualified. On January 1st of the year you make your first Roth 401(k) contribution, the five-year period begins.

Unless an exception applies, the taxable portion of your distribution may be subject to a 10% premature distribution tax in addition to any income tax due. Distributions after age 5912, distributions due to disability, qualified reservist distributions, and distributions to pay medical expenses are exempt from the penalty.

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Rollovers and conversions  Rollover of non-Roth funds

You may convert all or a portion of your in-service withdrawal into a conventional IRA or another possible Target plan that allows rollovers, tax-free, provided it meets the eligibility requirements for "eligible rollover distributions." With the exception of hardship withdrawals and mandatory minimum distributions after age 7012, most in-service withdrawals are generally eligible for rollover. Your plan administrator will send you a notice (referred to as a "402(f) notice") outlining the rollover rules, the withholding rules, and other tax implications if your withdrawal meets the requirements for a qualified rollover distribution. (If you do not rollover the assets promptly to another plan or IRA, your plan administrator will withhold 20% of the taxable part of your eligible rollover payout for federal income tax reasons.)

You can also turn over ('convert') an eligible non-Roth rollover distribution into a Roth IRA. Some 401(k) plans even permit a 'in-plan conversion' in which you can request an in-service withdrawal of non-Roth funds and have them transferred into a Roth account within the same 401(k) plan. In either instance, you will be subject to income tax on the converted amount (less any nontaxable after-tax contributions).

Rollover of Roth funds

Only a Roth IRA or another Roth 401(k)/403(b)/457(b) plan that allows rollovers will accept funds taken out of your Roth 401(k). (Once more, there is no carryover for hardship withdrawals.) However, take care to understand how a rollover may impact future IRA or plan payout taxation. For example, in the event that you roll over a nonqualified dividend from a Roth 401(k) to a Roth IRA, any future distributions from the IRA will be considered tax-free qualified distributions for the duration of the Roth IRA's five-year holding period. In other words, you won't be compensated for the time that these money were used to invest in your

Be informed

We advise our Target clients to familiarize themselves with the terms of Target's potential 401(k) plan in order to comprehend their specific withdrawal rights. The summary plan description (SPD) is an excellent starting point. Target will provide you with a copy of the SPD within 90 days of your plan enrollment.

Conclusion

Retirement planning is like a puzzle. Just as a puzzle requires different pieces that fit together to create a complete picture, retirement planning requires a variety of financial and lifestyle considerations that work together to create a fulfilling post-career life. This article offers valuable insights and guidance to help Target workers looking to retire, as well as existing retirees, put the pieces of their retirement puzzle together. From managing debt and creating a budget to investing for the future and planning for long-term care, this article provides a comprehensive framework for achieving a successful and satisfying retirement.