Early Withdrawals

June 21, 2011, 11:05 AM

A recent survey found that nearly 1 in 5 retirement plan participants has taken an early withdrawal from a retirement plan account within the past year in order to cover emergencies. Click here for the story.

Early retirement withdrawals, whether via hardship distributions, loans, in-service distributions for employees over age 59-1/2, or voluntary withdrawals from an IRA, are clearly not a wise move from a retirement savings perspective. Early withdrawal not only hamstrings the long-term growth of the retirement account, it also leads to premature tax liability, including in many cases an additional 10% penalty tax (for individuals below age 59-1/2).

Do employers owe a duty to employees to make it difficult to access the funds in their accounts, or perhaps to counsel employees to think twice about taking an early distribution? From a legal perspective, the answer is a clear and resounding no. The law governing retirement plans permits early withdrawals in many circumstances, and offers no incentive for employers to design their plans to prohibit or restrict early distribution. Employers are free to offer these options (or not offer them), and if offered, employees must be allowed to use them on a nondiscriminatory basis. In fact, one of the only ways employers can get into trouble in this arena is by administering their early withdrawal provisions in a way that places additional burdens on employees for exercising their rights under the plan for instance, by requiring employees to attend a financial counseling session prior to requesting a hardship distribution. An employee who is unwilling to attend a counseling session but otherwise satisfies the plans criteria for a hardship withdrawal could have a legitimate claim of prohibited discrimination against the plan administrator.

One thing employers can do is to opt out of the early withdrawal business altogether by amending plans to remove these options. Plans might be amended to permit loans but not hardship withdrawals, for instance, or to provide that certain categories of contributions (like profit sharing contributions) are not eligible for early withdrawal. The tax law provides neither an incentive nor a disincentive to include such provisions, so it is a matter of choice for each individual employer.

One thing to keep in mind, however: any early withdrawal provisions that are offered under the plan must be administered on a nondiscriminatory basis. An option available to one employee must be available under the same terms to all. --Shad C. Fagerland