The 11 most asked In-Service Distribution questions

An in-service withdrawal occurs when an employee takes a distribution from a qualified, employer-sponsored retirement plan, such as a 401(k) account, without leaving the employ of their company.  Read the 11 FAQs below to ensure you are informed on these distributions next time you are asked.

  1. When can a participant receive a distribution from a retirement plan while still working?

It depends. A plan may (but is not required to) allow participants to receive in-service distributions. In addition, certain conditions must be satisfied which are set forth under the Internal Revenue Code and regulations.

  1. Are the rules different depending upon the type of contributions?

Yes. Elective deferrals (i.e. 401(k) and Roth contributions) can only be distributed while a participant is still working under limited circumstances. The following in-service distributions are permissible, if provided for under the plan document:

  • Hardship distributions
  • Distributions on or after the date a participant has attained age 59 ½
  • Qualified reservist distributions
  • Distributions after a participant has become disabled (as defined under the terms of the plan)

Safe harbor nonelective and matching contributions may only be distributed upon reaching age 59 ½, hardship or disability. This also holds true for QNEC and QMAC account balances.

Profit sharing and employer matching contribution account balances may be distributed upon attainment of a stated aged (which may be less than age 59 ½), after the contributions have accumulated (or “aged”) in the plan for at least 2 years, after an employee has been a plan participant for at least 5 years, or upon a stated event.

Rollover and voluntary after-tax (non-Roth) contribution account balances may be distributed at any time.

Different rules apply to pension plan balances, which generally may not be distributed to an active employee prior to attainment of age 62.

  1. Are in-service distributions eligible for rollover?

Generally, yes. With the exception of hardship distributions, any of the in-service distributions described above are eligible for rollover.

  1. Are in-service distributions subject to the additional 10% income tax for early withdrawals?

Yes. Unless the participant has attained age 59 ½, the taxable portion of the distribution is generally subject to the additional 10% income tax. There are exceptions to this rule if the participant is disabled (as defined under the Internal Revenue Code) or if the distribution is a qualified reservist distribution.

  1. What qualifies as a “hardship” distribution?

The regulations provide “safe harbor” rules, which most plans follow. Under these rules, hardship distributions may be made for the following reasons:

  • To prevent foreclosure or eviction from a participant’s principle residence
  • To purchase a participant’s principal residence (excluding mortgage payments)
  • To pay for post-secondary education for a participant, his spouse, children or dependents for the next 12 months
  • To pay for unreimbursed medical expenses that would otherwise be deductible (without consideration to the deduction limit) for a participant, his spouse, children or dependents
  • To pay for funeral expenses for a participant’s deceased parent, spouse, child or dependent
  • To pay for expenses necessary to repair a participant’s principle residence as a result of a casualty
  • Expenses incurred as a result of a natural disaster in a federally declared disaster area
  • Medical, post-secondary educational, and funeral expenses for a participant’s primary beneficiary
  1. Are in-service distributions from Roth accounts taxable?

It depends. Roth contributions are not taxed when distributed, but the related earnings may be unless the distribution is a “qualified distribution”. In general, a distribution is a qualified distribution only if the distribution is being made on account of death, disability or attainment of age 59 ½ and the participant has had a Roth account under the plan for at least 5 years.

Distributions that are rolled over to a Roth IRA are not taxable.

  1. What are “Qualified Reservist” distributions?

A plan can allow participants who have been called to active duty for a period of more than 179 days (or indefinitely) to receive a distribution of their elective deferrals.

  1. Are distributions from voluntary after-tax accounts taxable?

Like Roth contribution account balances, the after-tax contribution portion of the account is not taxable but the related earnings are unless the distribution is rolled over to a traditional IRA. If rolled over to a Roth IRA, the related earnings are taxed.

  1. If a plan allows in-service distributions, can the provisions be removed?

A plan can remove a hardship distribution feature at any time; it is not a protected benefit. The other types of in-service distribution options discussed above are protected under the law. What this means is that any of these provisions may be removed prospectively; however, the participant account balances as of the effective date of the change must continue to be eligible for in-service distribution under the plan’s prior provisions.

  1. If an employee terminates and then is rehired, can he still receive a “termination” distribution?

No. After an employee has been rehired, he or she is no longer eligible to receive a termination distribution and would have to qualify for an in-service distribution under the terms of the plan.

  1. What happens if a plan issues an in-service distribution to a participant who doesn’t qualify to receive one under the terms of the plan?

The bottom line is that the plan sponsor must take corrective actions; this is plan qualification issue. The good news is the IRS provides methods for correcting such mistakes under their Employee Plans Compliance Resolution System (EPCRS). Generally, the employer must take steps to have the participant return the funds to the plan, along with related earnings, but there are other options as well.

To learn more about in-service distributions, please contact us and we will be happy to assist you.

What does it mean to be top-heavy?

In general, a plan is considered to be top-heavy when more than 60% of plan assets are attributable to “key employees” as of the “determination date”. Top-heavy plans are subject to certain minimum contribution and vesting requirements.

Who is a key employee?

A key employee is an employee who at any time during the plan year: (1) owned more than 5% of the company, (2) owned more than 1% of the company and had compensation in excess of $150,000, or (3) was an officer of the company with compensation in excess of a specified dollar amount ($180,000 for 2019). Note that stock attribution rules apply when determining ownership for this purpose.

What is the determination date?

For the first plan year, the determination date is the last day of the plan year. For subsequent years, the determination date is the last day of the prior plan year. Note that top-heavy status is measured annually and may change from year to year.

How is top-heavy status calculated?

The top-heavy ratio is calculated by comparing the account balances of key employees to non-key employees, after making certain adjustments. First, certain participant balances are excluded (i.e. rollover account balances from unrelated employers; account balances of terminated participants who did not work for the company during the year; and account balances of former key employees). Next, certain amounts are added back (i.e. distributions made on account of termination, death or retirement if the participant worked for the company during the year; and in-service distributions made within the 5-year period ending on the last day of the plan year).

 What are the minimum contribution requirements for top-heavy plans?

Generally, the employer must make a contribution on behalf of all non-key participants who were employed on the last day of the plan year equal to the lesser of 3% or the highest contribution rate of any key employee. Certain contributions count towards satisfying the top-heavy minimum requirement (e.g. employer matching contributions, profit sharing contributions, and forfeiture allocations). If a participant has already received an amount sufficient to satisfy the top-heavy minimum, no additional contributions must be made on their behalf.

Caution: Plans that allow for immediate entry for 401(k)/Roth purposes but have a longer eligibility period for employer contributions are still required to make top-heavy minimums for non-key participants who were only eligible for the 401(k)/Roth portion of the plan.

How is the highest contribution rate for key employees determined?

All contributions (other than rollover contributions) are considered when calculating the contribution rates for key employees. This means that 401(k) deferrals and Roth contributions are included.

What are the minimum vesting requirements?

Top-heavy plans must use either a 3-year cliff or 6-year graded vesting schedule. This requirement has little impact since most plans use vesting schedules that meet or exceed these standards.

Are safe harbor 401(k) plans exempt?

Safe harbor plans are generally not required to make top-heavy minimums if all non-highly compensated employees are eligible for the safe harbor contribution, and the employer makes no contributions to the plan other than (1) safe harbor matching contributions, (2) additional matching contributions that satisfy the safe harbor rules, or (3) safe harbor nonelective contributions.

Caution: Forfeiture allocations can trigger top-heavy minimums in safe harbor plans.

What happens if the employer doesn’t fund top-heavy minimums?

Failure to make top-heavy minimums is an operational failure that can jeopardize the qualified status of the plan. As a result, any “missed” top-heavy minimums must be funded along with related earnings.

If you have any questions regarding the top-heavy rules or would like to learn more, please contact us.