What should I do with my 401(k) when I retire?
By Jenn King
Key Takeaways:
If you keep your 401(k) in the Employer Plan and you are age 55 or older, you can take withdrawals from the plan without paying the 10% penalty.
If you roll the money over into an IRA you have more investment options; and if you are under age 59 ½, you can take distributions for higher education expenses or as a first-time home buyer without paying the 10% penalty.
You can combine multiple 401(k)s into one IRA for simplification.
If you are under 59 ½ and cash out all at once, you will pay a 10% IRS penalty and income taxes on the entire amount.
So, you’ve finally let the company know that you are ready to retire. You’ve given them notice of your last day and now they are scrambling to make sure they are prepared for your departure.
You’ve already done your planning. You know your plan looks great and you are ready to take some well-deserved time for yourself. But have you thought of everything? What about that 401k – what are your options? Should you rollover your IRA or keep it in the plan? Or maybe you cash it out and take that trip of a lifetime you’ve always wanted to do? Let’s take a look at your options.
OPTION 1 - Keep your 401k in the Employer Plan
Some things won’t change:
Investment Options –You’ll have the same investment options. If you are happy with the options, that may be fine. If you are looking for broader investment choices and better diversification in your retirement account, there are likely better options out there.
The investments are institutionally priced, so they are typically low cost. However, it will be important to review your annual 401(k) disclosure to be clear on the true cost.
Your account grows tax-deferred and if you take withdrawals from the account you will pay ordinary income tax on the entire withdrawn amount.
Some considerations:
If you have less than $5,000 in the plan, the money will be automatically sent to you.
Any time you take a distribution from the plan, they will automatically withhold 20% for taxes. You do not have the option to NOT withhold.
You will have to take Required Minimum Distributions (RMDs) when you turn age 72. However, instead of being able to aggregate your RMD’s from one account, your 401k will require you take out your RMD from your 401k in addition to your potentially aggregated RMD from a single IRA.
A good reason to keep it in your Employer Plan?
If you have planned well enough to retire before the age of 59 ½, as long as you are age 55 or older, you can take withdrawals from the plan WITHOUT paying the 10% penalty. You still have to pay ordinary income taxes, but the penalty becomes a non-issue.
OPTION 2 – Roll the money over into an IRA
What won’t change:
Your money continues to grow tax-deferred. With the roll over, there are no tax implications if you move the money from the employer plan directly into the IRA.
Some considerations:
Fees and expenses can vary between different providers. It will be important to do your research to make sure you understand how much you are paying for your investment advice.
A good reason to roll it over into an IRA?
Investment Options – you will have many more investment options to choose from than your employer plan
Strategic Tax Planning – When you take distributions, you can choose to withhold taxes or pay taxes when you file your taxes at the end of the year.
If you are under age 59 ½ you can take distributions for higher education expenses or as a first time homebuyer without paying the 10% penalty.
Simplification – you may want to combine your individual retirement accounts from your past employers into one IRA that will allow you easier management of your money as you age.
OPTION 3 – Cash Out!
This is absolutely the LAST thing you want to do with your 401(k) when you retire. Why? Because every dollar of your withdrawal is going to be taxed as ordinary income – ALL AT ONCE! And if you are under 59 ½ then you will also pay a 10% penalty on that money.
Let’s say your 401k is worth $250,000. You file Married Filing Jointly on your tax return. If there is no other income, you will pay about $42,000 in taxes. If you are also under age 59 ½ then you will pay an additional $25,000 early withdrawal penalty. So what are you left with? $183,000. That’s a tough pill to swallow when you worked all of those years to save for retirement!
The bottom line is that this is an individual decision as only you know your cash flow needs, tax situation and retirement goals. It is important that you do your due diligence and thoroughly explore your options or work with a Financial Planner to help evaluate the best steps for you and your family.
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