Restricted Access to Retirement Funds

In a number of prior posts, I’ve extolled the long-term benefits of tax-favored savings buckets—IRA’s, Roth IRA’s, 401(k) plans, 403(b) plans and the like. But you have to take the bad with the good. Today I will talk about restrictions on access to your funds, which you should consider in weighing the pros against the cons.

At the outset, let me emphasize that I’m only talking about employer plans, such as 401(k) plans. The financial institution holding your IRA or Roth IRA will not prevent you from accessing those accounts. There may be a tax penalty imposed (and that’s a subject for a later post), or even an early withdrawal penalty (for example, in a certificate of deposit), but you can at least get at your assets if you need to. With employer plans, however, you can only get at your account at certain times. Here’s a summary.

Plan Document. Your employer’s plan document controls. It says when you can and can’t get at your account. What, you ask, is a plan document? That’s the 60-page, fine-print, legalese opus that nobody has ever actually read. But the plan’s distribution provisions are supposed to be summarized in a shorter, more readable “Summary Plan Description.” That’s the 20-page document which you got when you were first hired 20 years ago, put in a drawer for 10 years, and then threw out.

401(k) Restrictions. By law, 401(k) plans are not allowed to provide for a distribution to you unless you have reached some triggering event. The common allowable triggering events are (i) termination of your employment, (ii) financial hardship, and (iii) reaching age 59-1/2. But it’s important to understand that while these are permissible triggering events, your employer is not required to include them in its plan. So don’t go pounding your fist and insisting you’ve incurred a financial hardship if your employer’s plan doesn’t include that as a triggering event.

Latest Commencement Date. It is very common for 401(k) plans to provide for a distribution at your option shortly after you terminate employment. Very common, but not mandatory. The plan could require you to wait to get your distribution, as late as age 65. That kind of restriction is more common in pension plans, but it could be included in a 401(k) plan. In my entire career, I have never encountered that kind of restriction in a 401(k) plan, although it’s theoretically possible.

No Employer Discretion. Employer plans must not allow your company to exercise discretion in distributing or withholding benefit payments. So your employer can’t—legally anyway—delay distribution (if the plan provides for it) just because he doesn’t like you; nor can he accelerate distribution just because he does.

Method of Distribution. Your employer’s plan document governs not only when you can gain access to your account, but also how your account might be distributed. It’s typical—but not required—for a 401(k) plan to offer a lump sum. The plan might also offer an annuity, or a joint and survivor annuity for the lives of you and your spouse, or even installments over a stated period of years.

Spouse’s Rights. Federal law gives your spouse certain rights in your 401(k) account. Most notably, you must name your spouse as beneficiary in the event of your death before you’ve depleted the account. Also, if you opt for an annuity from a 401(k) plan, it must be in the form of a joint and survivor annuity with your spouse. Your spouse may waive these rights if certain formalities are met.

No Elimination of Distribution Options. Once a plan has given you a distribution option, your employer generally can’t take it away by amending the plan, at least with respect to your existing account balance. There are, however, a bunch of exceptions to this general rule.

Mandatory Distributions. On the other side of the coin, neither you nor the plan may defer distributions forever. There’s a set of rules, called the Required Minimum Distribution rules, which generally requires that you begin distributions no later than age 70-1/2 (or, in the case of an employer plan, retirement if later); and you must deplete the account at a certain minimum prescribed rate. I think I’ll provide more details on Required Minimum Distributions in a future post.

Loans. Some 401(k) plans allow you to borrow from your account. That’s not really a distribution because you have to pay it back. But it’s a limited form of access that may prove useful in a pinch. Plan loans are not a great idea, and that’s something I’ll discuss in a later post.

So these are the restrictions you’ll need to weigh against the tax benefits of shifting your savings into a tax-favored plan. In tomorrow’s post, I’ll talk about a different tax detriment—the 10% penalty tax on distributions before age 59-1/2.