Mandatory Withholding for In-Service Withdrawals

You can tap your retirement nest egg by making an in-service withdrawal.

Jupiterimages/ Images

Employer sponsored pension plans such as 401(k)s are designed to provide you with an income source for your retirement years. In certain circumstances, you can make withdrawals while you're still working. In-service withdrawals are subject to a mandatory federal tax withholding, but this applies only if you take possession of the money.

In-Service Withdrawals

Under the federal tax code, in-service withdrawals related to financial hardship are permitted. However, your employer ultimately decides whether to include a provision for such withdrawals in your plan. Likewise, a retirement plan may include a provision for in-service withdrawals so you can move retirement money into a self-directed plan such as an Individual Retirement Account. Once you reach the age of 59 1/2, you can roll over both your contributions and earnings, as well employer matching contributions. However, it can take up to seven years for your employer's contributions to become vested at which point that money belongs to you. If you're younger than 59 1/2, you can roll over any cash in the account other than money that was contributed by your current employer.


In-service withdrawals are subject to the same 20 percent federal tax withholding that applies to other employer-sponsored pension plan withdrawals. If you plan to reinvest the cash in an IRA, you must replenish the withdrawal proceeds with cash from another source. You can claim back the money withheld for taxes when you file your annual tax return. The same rules apply to any taxes withheld at the state level. You have a 60-day window to reinvest the cash in a retirement plan. If you fail to do so, the withdrawal is classified as a distribution and subject to income taxes. Depending on your tax bracket, you might end up paying more tax or eventually get some money back.

Roth Accounts

Some retirement plans include a designated Roth account in which case your contributions are made on an after-tax basis. If your plan permits withdrawals, you can access your cash without paying any taxes as long as you are at least 59 1/2 and have held the account for five years or more. If you do not meet both of these requirements, your in-service Roth withdrawals are subject to the 20 percent federal tax withholding. However, you only pay the taxes on your earnings because your principal was taxed prior to being invested in the account.

Direct Transfers

If you plan to move money from your pension plan into another retirement account, you can avoid the mandatory withholding by arranging a direct transfer. This involves directing your account administrator to send the money directly to the new account custodian. During the transfer, you have no access to the cash. Consequently, the withholding is inapplicable because the money never leaves the tax shelter of a retirement account. Likewise, you do not have to contend with the 60-day window for the completion of the transfer.


Aside from ordinary income tax, you also have to pay a 10 percent penalty on in-service withdrawals made before you reach the age of 59 1/2. Depending on your tax bracket, the 20 percent withholding might be sufficient to cover both your ordinary income taxes and this penalty tax. If not, you can instruct your plan custodian to withhold additional money, or you can pay the difference when you file your taxes. Regardless of age, you avoid the penalty fee if you make a withdrawal after becoming disabled and when faced with certain other hardships.