What Is In-Service Withdrawal?

In-Service Withdrawal Explained in Less Than 5 Minutes

Person sitting in a coffee shop contemplating an early retirement withdrawal
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In-service withdrawal occurs when you take out funds from your employer-sponsored retirement plan while still working or before being let go from your job.

Learn more about in-service withdrawals, when they're allowed, and what penalties you might incur by taking out cash. Plus, find out what the effects could be on your retirement.

Definition and Examples of In-Service Withdrawal

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

  • Retirement at age 59 1/2
  • Disability
  • Termination from your job
  • Death

If one of those factors applies to you, then it is a regular withdrawal.

  • Alternate name: Early distribution

How In-Service Withdrawal Works

Making an in-service withdrawal from your 401(k) is almost never a good idea. In just about every case, you will be subject to taxes and penalties. Taking an early distribution will also reduce the value of your 401(k). This is often permanent. You will lose the bonus of non-taxable compounding, which will leave you with less money when you retire.

There are two types of employer-sponsored retirement accounts. 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 standards for an employer to offer a pension plan.

Defined Benefit Retirement Accounts 

Defined benefit retirement accounts are administered by a pension fund manager. These plans usually require the employee to contribute a percentage of their salary to their account. The company often 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. You can’t withdraw any money—including the money you put in—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 now much less common.

Defined Contribution Retirement Accounts

Defined contribution retirement plans often require that both the employee and the employer contribute to the plan. Often, the employer will match the employee's contribution up to a certain percent. You may also have to be vested. The vesting 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. The rules of these plans are set by the IRS.

Other Retirement Accounts

There are other types of retirement accounts, including:

  • Thrift Savings Plans: The retirement fund for federal government employees. This type of plan has rules that are very much like those of the 401(k).
  • Section 457(b): These are non-qualified, eligible deferred compensation plans for state and local governments and tax-exempt organizations. They follow different rules. 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 a SEP IRA. SIMPLE IRAs have vesting requirements. 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. Also, you must be facing 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 that the employee can’t get the money from other sources like wages or loans, because that would add to the hardship.

The funds can only come from employee/employer matching contributions and not from any income earned on them.

Reasons for an In-Service Withdrawal

In 2017, the IRS set 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 job loss, render withdrawals allowable.
  • Different types of retirement accounts have different rules.
  • There is always a tax consequence to early distribution, meaning that it should only be used as a last resort.