401(k) Distribution Dilemmas
How you will take your 401(k) distributions when you retire can be an
important consideration in executing your post-retirement plan.
We all look forward to the day when we can finally kick back, relax and collect our carefully-planned and
hard-earned retirement savings. But rushing into withdrawing your retirement funds could cost you a
great deal of money in taxes. That’s why planning now for that day is so important.
If your employer requires distribution of your 401(k) plan funds when you leave
employment, rolling it over to an IRA may be your only option for avoiding
unnecessary taxes. A lump sum distribution directly to you will probably bump
you into a higher tax bracket.
Some employers, however, allow retirees to leave those funds in the
company’s 401(k) plan. Given the option – leaving your money in the plan or
rolling it into an IRA – which do you choose?
By leaving the money in the 401(k), you can continue to let it grow tax-deferred.
You remain subject to the rules of the plan and the investment options offered,
and to any changes the employer makes to the plan after you retire. Money in
your 401(k) account is protected from creditors in a personal bankruptcy or
lawsuit. If you die, your beneficiaries have to take a lump sum distribution.
Despite the ease and attraction of leaving your money in your 401(k) plan, if
the plan has limited or poor investment choices, you may want to opt for the
Rolling your 401k savings into an IRA allows you to continue investing and
growing your assets tax deferred. It also gives you more control over when
and how to invest your money and, to some extent, when you take distributions.
If you have multiple qualified plans (for example, accounts at several different
employers), consolidating them into an IRA can not only make them easier to
manage, but may help you qualify for break points or sales charge discounts
in mutual funds. If you die, distribution of IRA funds to your beneficiaries may
be spread over several years. However, funds in your IRA do not have
protection from creditors.
You should note that rollovers to an IRA from other qualified plan accounts are
best made directly to avoid incurring any penalties or additional taxes. You will
be subject to a 20% automatic withholding for income tax plus a 10% penalty,
if you are under age 59½. Withdrawn funds must be in the new account within
60 days, or the amount you received will be taxable.
You are not required to take distributions from a qualified plan – 401(k) or IRA – until age 70½. The
benefits of tax-deferred compounding usually make it advantageous to access these accounts after
using funds from other accounts. Required minimum distributions – the amount the government makes
you take out of qualified plans after age 70½ – cannot be used as contributions to another qualified plan.
No matter which method you choose for taking distributions from your 401(k) during retirement, the key is
stick to your investment plan and make sure that you’re choosing the most appropriate method of
withdrawal. Your financial professional can be an important resource for helping you make those
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