Tennessee Insurance Practice Exam

What must an employee do with an in-service distribution from a 401(k) plan to avoid immediate tax consequences?

1. Determine eligibility first

2. Withdraw it in cash

3. Roll it over into an IRA

4. Leave it in the 401(k) plan

The correct answer is: Roll it over into an IRA

To avoid immediate tax consequences from an in-service distribution from a 401(k) plan, an employee must roll it over into an Individual Retirement Account (IRA). This action enables the employee to defer taxes on the amount transferred, preserving the tax-advantaged status of the funds. When funds from a 401(k) are rolled over to an IRA, they continue to grow tax-deferred until withdrawn during retirement, allowing for potential investment growth without the burden of immediate taxation. While other options may be valid in different contexts, they do not serve the specific purpose of avoiding immediate tax repercussions. For example, determining eligibility first does not address the tax implications both in terms of process and consequence. Withdrawing the funds in cash results in a taxable event at the time of the distribution, meaning the employee would face immediate tax liabilities. Leaving the distribution in the 401(k) plan could potentially allow for continued tax deferral, but it does not facilitate the movement of funds or provide the flexibility that rolling it over to an IRA does. Thus, rolling over into an IRA is the most effective strategy to mitigate immediate tax consequences.