One of the biggest decisions new retirees must make is what
to do with the money in their company-sponsored 401(k) plan. You can generally
maintain your 401(k) with your former employer or roll it over into an
individual retirement account. IRAs maintain the same tax benefits of a 401(k)
and typically offer more investment options, but there are instances when it
makes sense to keep your money in the 401(k) plan.
Here's how to decide what to do with your 401(k) when you
retire:
You can start 401(k) distributions without penalty after age
59 1/2.
If you leave your job at age 55 or older, you can start
penalty-free withdrawals early.
Remember to start required minimum distributions after age
72, unless you are still working.
Take steps to keep costs low.
Evaluate the investment options in your 401(k) plan.
Consider leaving the money in your 401(k) plan.
Consider rolling over to an IRA.
Start 401(k) Distributions
If you are age 59 1/2 or older, you can start taking
withdrawals from your 401(k) without triggering the early withdrawal penalty.
You will owe income tax on each distribution from a traditional 401(k).
Factor in the Age 55 Rule
If you leave your job in the year you turn age 55 or later,
you may be able to start penalty-free 401(k) withdrawals as early as age 55.
However, if you roll the funds over to an IRA, you will be required to wait
until 59 1/2 to avoid the 10% early withdrawal penalty.
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Take Required Minimum Distributions
If you are 72 or older, you will need to take required
minimum distributions from your 401(k) account each year. "You don't have
to touch the 401(k) until you are 72," says Morgan Hill, CEO of Hill &
Hill Financial in Woodstock, Georgia. If you stay on the job past age 72 and
don't own 5% or more of the company, you may be able to continue to delay
401(k) withdrawals while you are working if your plan allows it. "You
don't have to take mandatory distributions until you actually leave," Hill
says.
Distributions from traditional retirement accounts count as
income. Make sure you plan out when you will begin taking the distributions to
lessen the tax impact. A fee-only financial planner or accountant can help you
determine the best way to start drawing down your assets and provide insight
about the tax impact of your decisions.
Keeps Costs Low
Take a look at the administrative and investment costs
associated with your 401(k) plan. You can look up the 401(k) plan fees you are
paying on your annual 401(k) fee disclosure statement. You may be able to move
your money into lower cost funds within the plan. You can also compare the fees
and investment costs in your 401(k) plan to potential IRAs. Your company may
have negotiated low fees with the plan administrator, especially if you are
with a large employer. But if your 401(k) plan has high fees, you could find a
more reasonably priced IRA.
Evaluate Investment Options
Most 401(k) plans have a limited investment selection. If
you are happy with the investments that are provided, there's no reason to
switch. However, IRAs have a wider selection of investment options than 401(k)
plans. "I would always advocate to roll it into an IRA," says
Mitchell Katz, a partner and financial advisor at Capital Associates Wealth
Management in Bethesda, Maryland. "Typically, 401(k)s don't have a big
catalog of investment choices."
The typical 401(k) plan might have a few dozen funds, while
an IRA can provide thousands of investment choices including a full gamut of
individual securities, mutual funds, bonds and exchange-traded funds. "By
putting it into an IRA rollover, you should be able to build the portfolio you
want and get the rate of return you need so you don't outlive your money,"
Katz says. "Because you have more choices, you should be able to get a
little more downside protection."
Consider Leaving Your Money in the 401(k) Plan
There are several reasons to leave your 401(k) money with
your company when you retire. If your 401(k) plan has cost-effective investment
options, there may be little reason to move your money. “If they work for a
large employer, that employer, due to economies of scale, typically can
negotiate fees and expenses for that 401(k) plan that are really low for the
participants in the plan,” says M. Tyler Ozanne, a certified financial planner
and president of Ozanne Financial Services in Dallas.
If you are in financial trouble, it is best to leave your
money in a 401(k) plan. "The bankruptcy courts cannot touch your 401(k)
plan, but they might be able to take money from your IRA account," says
Tiffany Kent, founding partner of Wealth Engagement in Atlanta, Georgia.
Consider Rolling Over to an IRA
It can be difficult to manage and track your retirement
investments when you have multiple IRAs and 401(k) accounts. Consolidating your
retirement accounts by rolling your savings into a single IRA can simplify your
financial life. If you plan to take on another job in retirement, you could
also move your money into your new employer plan.
IRAs provide a wider selection of investments than 401(k)
plans, and you can shop around for accounts with low fees. A direct rollover
from a 401(k) to an IRA is a penalty-free and tax-free transaction, and you can
choose an IRA with the investments you want at a reasonable price.
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