What Is In-Service Withdrawal?

Definition & Examples of In-Service Withdrawal

Person sitting in a coffee shop contemplating an early retirement withdrawal
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In-service withdrawal occurs when an employee takes a withdrawal of funds from a qualified employer-sponsored retirement plan while still working or before experiencing a triggering event such as termination from the company.

What Is In-Service Withdrawal?

You're making an in-service withdrawal from your employer-sponsored retirement plan if none of the following conditions exists:

  • retirement at age 59½
  • disability
  • termination from the company
  • death

If one of those conditions does exist, then it is a regular withdrawal.

  • Alternate name: Early distribution

How In-Service Withdrawal Works

Making an in-service withdrawal from your employer-sponsored retirement plan is almost never advisable. In just about every case, you will be subject to taxes and penalties. Making an in-service withdrawal will also reduce the value of your retirement account. That reduction is usually permanent because you lose the benefit of non-taxable compounding. This leaves you with less money when you retire.

There are two types of employer-sponsored retirement accounts and each works differently when it comes to in-service withdrawal. Both types are covered under the Employee Retirement Income Security Act of 1974 (ERISA) which sets the minimum standards for an employer to offer a pension plan.

Defined Benefit Retirement Accounts 

Defined benefit retirement accounts are administered by a pension fund manager. Defined benefit plans usually require the employee to contribute a percentage of their salary to their retirement account and, often, the company matches that contribution in some way.

One of the biggest differences between the defined benefit and defined contribution plans is that you usually have to be vested in the defined benefit plan before you receive any benefits. You can’t withdraw any money—including your own contributions—until you are vested. When you retire, you get a set benefit payment per month. Defined benefit plans include many teacher's retirement plans (TRS) but they are becoming much less common.

Defined Contribution Retirement Accounts

Defined contribution retirement plans usually require that both the employee and the employer contribute to the plan in some matching arrangement. You may also have to be vested when you have a defined contribution plan, but the vesting is different than in the defined benefit plan and could be on a schedule. You can always draw out your own funds if you have a defined contribution plan, but you can only draw out the employer’s funds according to the vesting schedule—if there is one. Examples of defined contribution plans are 401(k) and 403(b) plans and the rules are established by the Internal Revenue Service.

Other Retirement Accounts

In addition, there are the following accounts:

  • Thrift Savings Plans: The retirement fund for federal government employees has very similar rules and conditions to the 401(k).
  • The 457(b): This is a non-qualified employee retirement plan for state and local government workers. It follows different rules and employees can make an in-service withdrawal at any time.
  • SEP and SIMPLE Individual Retirement Accounts (IRAs): These are used in small businesses. There are no rules for in-service withdrawal for the SEP IRA. SIMPLE IRAs have vesting requirements and the penalty for in-service withdrawal is increased to 25% if you have not been vested, which is generally during the first two years you are in the plan.

When Can In-Service Withdrawals Be Taken?

In accounts that permit in-service withdrawals, there are allowable circumstances. The need for the in-service withdrawal must be immediate and it must be a heavy financial burden.

The in-service withdrawal must be limited to the amount of the need. This is called a hardship in-service withdrawal. It assumes the employee can’t get the money from other sources like wages or loans because that would add to the amount of the employee’s financial hardship.

The available funds can only come from employee/employer matching contributions and not from any income earned on them—such as dividend and interest income.

Reasons for an In-Service Withdrawal

In 2017, the IRS established six allowable reasons for an in-service withdrawal:

  1. Medical expenses for the employee, spouse, dependents, or beneficiary
  2. Costs directly related to the purchase of the employee’s principal residence, including mortgage payments
  3. Tuition and all related post-secondary educational costs, including room and board, for the employee, spouse, children, spouse’s children, and beneficiary for the next 12 months
  4. Payments necessary to prevent the foreclosure of the employee’s principal residence or eviction of the employee from that residence
  5. Funeral expenses for the employee, spouse, children, or beneficiary
  6. Certain expenses to repair damage to the employee’s principal residence

Key Takeaways

  • In-service withdrawal occurs when an employee takes funds from a qualified employer-sponsored retirement plan while still working.
  • Certain triggering events, such as termination, render withdrawals allowable.
  • Different types of retirement accounts have different rules.
  • There is always a tax consequence to early distribution, meaning it should only be used as a last resort.