3M Employees: Exploring Your Options for In-Service Withdrawals from Your 401(k) Plan

If you have worked at a corporation,  you may be familiar with the rules for putting money into a 401(k) plan. But are you familiar with the rules for taking your money out? Federal law limits the withdrawal options that a 401(k) plan can offer. But a 401(k) plan may offer fewer withdrawal options than the law allows, and may even provide that you can't take any money out at all until you leave 3M. However, many 401(k) plans are more flexible.

First, consider a plan loan  

Many 401(k) plans allow you to borrow money from your own account. A loan may be attractive to our 3M clients who don't qualify for a withdrawal, don't want to incur the taxes and penalties that may apply to a withdrawal, or don't want to permanently deplete their retirement assets. (Also, you must take any available loans from all plans potentially maintained by 3M before you're even eligible to withdraw your own pretax or Roth contributions from a 401(k) plan because of hardship.)

In general, you can borrow up to one-half of your vested account balance (including your contributions, 3M's potential contributions, and earnings), but not more than $50,000.

You can borrow the funds for up to five years (longer if the loan is to purchase your principal residence). In most cases, you repay the loan through payroll deduction, with principal and interest flowing back into your account. But keep in mind that when you borrow, the unpaid principal of your loan is no longer in your 401(k) account working for you.

Withdrawing your own contributions  

If you've made after-tax (non-Roth) contributions, your 401(k) plan can let you withdraw those dollars (and any investment earnings on them) for any reason, at any time. You can withdraw your pretax and Roth contributions (that is, your 'elective deferrals'), however, only for one of the following reasons—and again, only if your plan specifically allows the withdrawal:

• You attain age 59½
• You become disabled
• The distribution is a 'qualified reservist distribution'
• You incur a hardship (i.e., a 'hardship withdrawal')

Hardship withdrawals are allowed only if you have an immediate and heavy financial need, and only up to the amount necessary to meet that need. In most plans, you must require the money to:

• Purchase your principal residence, or repair your principal residence damaged by an unexpected event (e.g., a hurricane)
• Prevent eviction or foreclosure
• Pay medical bills for yourself, your spouse, children, dependents, or plan beneficiary
• Pay certain funeral expenses for your parents, spouse, children, dependents, or plan beneficiary
• Pay certain education expenses for yourself, your spouse, children, dependents, or plan beneficiary
• Pay income tax and/or penalties due on the hardship withdrawal itself

Investment earnings aren't available for a hardship withdrawal, except for certain pre-1989 grandfathered amounts.

But there are some disadvantages to hardship withdrawals that our clients from 3M should keep in mind, in addition to the tax consequences described below. You can't take a hardship withdrawal at all until you've first withdrawn all other funds, and taken all nontaxable plan loans, available to you under all retirement plans potentially maintained by 3M. And, in most 401(k) plans, the employer, such as 3M, must suspend your participation in the plan for at least six months after the withdrawal, meaning you could lose valuable potential 3M-matching contributions. Hardship withdrawals can't be rolled over. So it's important for 3M employees to think carefully before making a hardship withdrawal.

Withdrawing employer contributions  

Getting employer dollars out of a 401(k) plan can be even more challenging. While some plans won't let you withdraw employer contributions at all before you terminate employment, other plans are more flexible, and let you withdraw at least some vested employer contributions before then. 'Vested' means that you own the contributions and they can't be forfeited for any reason. In general, a 401(k) plan can allow you to withdraw vested company matching and profit-sharing contributions if:

• You become disabled
• You incur a hardship (your employer has some discretion in how hardship is defined for this purpose)
• You attain a specified age (for example, 59½)
• You participate in the plan for at least five years, or
• The employer contribution has been in the account for a specified period of time (generally at least two years)

Taxation  

Your own pretax contributions, company contributions, and investment earnings are subject to income tax when you withdraw them from the plan. If you've made any after-tax contributions, they'll be nontaxable when withdrawn. Each withdrawal you make is deemed to carry out a pro-rata portion of taxable and nontaxable dollars.

Your Roth contributions, and investment earnings on them, are taxed separately: if your distribution is 'qualified,' then your withdrawal will be entirely free from federal income taxes. If your withdrawal is 'nonqualified,' then each withdrawal will be deemed to carry out a pro-rata amount of your nontaxable Roth contributions and taxable investment earnings. A distribution is qualified if you satisfy a five-year holding period, and your distribution is made either after you've reached age 59½, or after you've become disabled. The five-year period begins on the first day of the first calendar year you make your first Roth 401(k) contribution to the plan.

The taxable portion of your distribution may be subject to a 10% premature distribution tax, in addition to any income tax due, unless an exception applies. Exceptions to the penalty include distributions after age 59½, distributions on account of disability, qualified reservist distributions, and distributions to pay medical expenses.

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Rollovers and conversions  Rollover of non-Roth funds  

If your in-service withdrawal qualifies as an 'eligible rollover distribution,' you can roll over all or part of the withdrawal tax-free to a traditional IRA or to another potential 3M plan that accepts rollovers. In general, most in-service withdrawals qualify as eligible rollover distributions except for hardship withdrawals and required minimum distributions after age 70½. If your withdrawal qualifies as an eligible rollover distribution, your plan administrator will give you a notice (a '402(f) notice') explaining the rollover rules, the withholding rules, and other related tax issues. (Your plan administrator will withhold 20% of the taxable portion of your eligible rollover distribution for federal income tax purposes if you don't directly roll the funds over to another plan or IRA.)

You can also roll over ('convert') an eligible rollover distribution of non-Roth funds to a Roth IRA. And some 401(k) plans even allow you to make an 'in-plan conversion'--that is, you can request an in-service withdrawal of non-Roth funds, and have those dollars transferred into a Roth account within the same 401(k) plan. In either case, you'll pay income tax on the amount you convert (less any nontaxable after-tax contributions you've made).

Rollover of Roth funds  

If you withdraw funds from your Roth 401(k) account, those dollars can only be rolled over to a Roth IRA, or to another Roth 401(k)/403(b)/457(b) plan that accepts rollovers. (Again, hardship withdrawals can't be rolled over.) But be sure to understand how a rollover will affect the taxation of future distributions from the IRA or plan. For example, if you roll over a nonqualified distribution from a Roth 401(k) account to a Roth IRA, the Roth IRA five-year holding period will apply when determining if any future distributions from the IRA are tax-free qualified distributions. That is, you won't get credit for the time those dollars resided in the 401(k) plan.

Be informed  

We recommend that our clients from 3M become familiar with the terms of 3M's potential 401(k) plan to understand your particular withdrawal rights. A good place to start is the plan's summary plan description (SPD). 3M will give you a copy of the SPD within 90 days after you join the plan.