In-Service Withdrawals from 401(k) Plans For Kraft 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. However, a 401(k) plan may offer fewer withdrawal options than the law permits and may prohibit you from withdrawing any funds until you depart Kraft. Nevertheless, many 401(k) plans are more adaptable.

Recent research by Fidelity Investments shows that more 60-year-olds are choosing to take in-service withdrawals from their 401(k) plans to pay off debt or cover unexpected expenses. According to their analysis, nearly 1 in 5 60-year-olds took an in-service withdrawal in 2020, a significant increase from previous years. While it's important to carefully consider the potential impact of such withdrawals on retirement savings, for those with pressing financial needs, an in-service withdrawal can provide a valuable source of liquidity. (Source: Fidelity Investments, 'In-Service Withdrawals from 401(k) Plans: What You Need to Know,' March 2021).

First, consider a plan loan

Numerous 401(k) plans permit you to obtain funds from your account. Clients of Kraft 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 Kraft 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, Kraft'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:

• You attain age 59½
• You become incapacable
• It is a 'qualified reservist distribution'
• 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:

• Purchase or renovate your primary residence if it was damaged by an unforeseen event (e.g., a hurricane).
• Avoid evictions and foreclosures
• Pay medical expenses for yourself, your spouse, your children, or plan beneficiaries.
• Pay specific funeral expenses for your parents, spouse, dependent children, or plan beneficiary.
• Pay for certain education expenses for yourself, your spouse, your offspring, or a plan beneficiary.
• 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 Kraft 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 Kraft may potentially maintain. And, in the majority of 401(k) plans, the employer, such as Kraft, 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 Kraft matching contributions. Hardship withdrawals are not eligible for rollover. Therefore, Kraft employees should closely consider a hardship withdrawal before making one.

Withdrawing employer contributions

Obtaining employer contributions from a 401(k) plan can be even more difficult. While some plans prohibit you from withdrawing any employer contributions prior to employment termination, others are more accommodating and permit you to withdraw at least some vested employer contributions. Contributions that have been 'vested' cannot be forfeited under any circumstances. In general, a 401(k) plan may permit you to withdraw company matching and profit-sharing contributions that have vested if:

• You become incapacable
• Your employer has some discretion regarding the definition of hardship for this purpose.
• You reach a certain age (for example, 59 12)
• You have participated for at least five years, or
• 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.

Your Roth contributions and investment earnings on them are taxed separately: if your distribution is 'qualified,' it will be completely exempt from federal income tax. If your withdrawal is 'nonqualified,' each withdrawal will be treated as a proportional distribution of your nontaxable Roth contributions and taxable investment earnings. A distribution is qualified if a five-year holding period is satisfied and the distribution is made after reaching age 5912 or becoming disabled. The five-year period commences on January 1 of the year in which you make your first Roth 401(k) contribution.

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

If your in-service withdrawal qualifies as a 'eligible rollover distribution,' you may transfer over all or a portion of it tax-free into a traditional IRA or another potential Kraft plan that accepts rollovers. In general, the majority of in-service withdrawals are eligible for rollover, with the exception of hardship withdrawals and required minimum distributions after age 7012. If your withdrawal qualifies as a qualified rollover distribution, your plan administrator will provide you with a notice (a '402(f) notice') that explains the rollover rules, the withholding rules, and other tax considerations. (Your plan administrator will withhold 20% of the taxable portion of your eligible rollover distribution for federal income tax purposes if you do not rollover the funds immediately to another plan or IRA.)

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

If you withdraw money from your Roth 401(k), you can only transfer it over to a Roth IRA or another Roth 401(k)/403(b)/457(b) plan that accepts rollovers. (Once more, hardship withdrawals are unable to be carried over.) But be careful to comprehend how a rollover will affect the taxation of future IRA or plan distributions. For instance, if you transfer over a nonqualified distribution from a Roth 401(k) to a Roth IRA, the Roth IRA's five-year holding period will be used to determine if future distributions from the IRA are tax-free qualified distributions. That is, you will not receive credit for the time these funds were invested in your 

Be informed

We advise our Kraft clients to familiarize themselves with the terms of Kraft's potential 401(k) plan in order to comprehend their specific withdrawal rights. The summary plan description (SPD) is an excellent starting point. Kraft 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 Kraft 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.