IN-SERVICE 401(k) WITHDRAWALS & INCOME PLANNING
An option you can use to develop your retirement income plan while you work.
Can you withdraw money from your 401(k) while you are still employed? Not everyone should; not everyone can. However, if you can, it may mean that you can effectively implement part of your retirement income plan before you retire.
If your 401(k) plan permits it, you can take an in-service withdrawal and redirect some of your 401(k) funds into another investment vehicle that offers you income guarantees.
The reasons why. A non-hardship withdrawal can provide you with early access to a portion of your retirement assets, freeing you to manage them as you wish. If the mix of funds in your 401(k) have taken a big hit lately, you might be wondering how some of those assets would do if they were invested differently.
The self-directed IRA option. Some people are withdrawing assets from qualified retirement plans such as 401(k)s and place them in self-directed IRAs. An SD-IRA can allow you to invest your assets in real estate, commodities, and other sectors indirectly correlated or uncorrelated to stocks. While many kinds of IRAs can be converted to self-directed IRAs, you need to have an IRA custodian that will allow an SD-IRA and let you make non-traditional investments using IRA assets. This IRA custodian has to be a registered trust company.1
You can take a self-directed IRA one step further and set up an IRA LLC. With an IRA LLC, you have “checkbook” control and don’t need your IRA custodian’s approval to make non-traditional investments.1,2
Many SD-IRA owners invest in income property or other forms of real estate. Contrary to public perception, IRA assets may be invested in real estate and other options besides securities (providing your IRA custodian allows this). There are some notable prohibitions: IRS Code Section 401 IRC 408(a)(3) prohibits life insurance contracts from being held in IRAs, and IRS Publication 590 states that your IRA will be hit with additional taxes if you invest in collectibles.3,4
The 72(t) strategy to avoid the early withdrawal penalty. If you are still working and pull money out of your 401(k) before age 59½, you will almost certainly pay a 10% early withdrawal penalty plus income taxes on the money you take out.5 But you might be able to make early withdrawals with the help of IRS Rule 72(t).
Rule 72(t), based on life expectancy, lets you schedule fixed income withdrawals for five years or until you reach 59-1/2, whichever is longer.6 It lets you receive fixed, equal payments according to IRS calculations.
First things first: make sure you can do this. Talk with your employee benefits officer at work, and see that the Summary Plan Description (SPD) permits non-hardship withdrawals. Talk with your financial or tax advisor to make sure this is an appropriate move for you given your overall financial plan. If you know you’ll need more retirement income, there can be real merit to reinvesting early withdrawals from a 401(k) in vehicles that generate it.
1 ira123.com/self-directed-ira-faq/#question4 [6/9/09]
2 realtytimes.com/rtpages/20060320_irarealestate.htm [3/20/06]
3 law.cornell.edu/uscode/26/usc_sec_26_00000408—-000-.html [1/3/07]
4 irs.gov/publications/p590/ch01.html#en_US_publink10006396 
5 money.cnn.com/magazines/moneymag/money101/lesson23/index.htm [11/10/08]
6 money.cnn.com/2001/06/08/strategies/q_askexperts_disabled/ [6/8/01]