A major decision for those who are newly retired, or planning on retiring soon, is deciding what to do with the savings accumulated in their company’s 401(k) plan. This article discusses the various factors to consider before making a decision.
How to handle your 401(k) plan when you retire
If you’re newly retired or planning to retire soon, you’ll need to decide what to do with the savings you’ve accumulated in your company’s 401(k) plan. If you don’t need to tap the funds right away, it’s generally best to let them continue earning investment income on a tax-deferred basis for as long as possible. But should you leave the funds in your employer’s plan or roll them over into an IRA? If your account balance is $5,000 or more, you’re permitted to keep your money in a former employer’s plan.
The following are some of the factors to consider in making this decision. The discussion assumes that you have a traditional 401(k) plan account. If you have a Roth 401(k) account, different considerations may come into play.
IRAs offer a wider selection of investment options than 401(k) plans. Even if your company has carefully selected a menu of high-quality investments, your choices will likely be limited to 20 or 30 funds, while IRA owners may choose from among thousands of funds and individual securities. This makes it easier to build a well-diversified portfolio with an asset mix that’s appropriate for your financial needs, risk tolerance, and time horizon.
Fees and costs
Both 401(k) plans and IRAs generate fees and investment costs and, because they come out of your returns, they’re easy to overlook. But these expenses can have a significant impact on the performance of your retirement funds, so do your homework. Often, it’s possible to find an IRA with lower fees than your 401(k) plan, but in some cases, it may be cheaper to leave your money in the plan.
Ordinarily, if you withdraw money from a 401(k) plan or IRA before age 59½, you’ll owe a 10% penalty (in addition to taxes at your ordinary-income tax rate). There’s an exception, however, that allows you to take penalty-free withdrawals from your former employer’s 401(k) plan if you retire or otherwise leave your job when you’re 55 or older. So, if you’ll need to withdraw funds before you reach age 59½, it may be better to leave them in your 401(k).
Your work plans
If you’re approaching age 70½, consider the impact of required minimum distributions (RMDs). Normally, you must begin taking taxable RMDs from 401(k) plans or IRAs when you reach that age. But suppose you’re taking partial or phased retirement and will continue working for your employer part-time past age 70½? Some 401(k) plans allow you to postpone RMDs until the year you fully retire, so it may make sense to leave your money in the plan.
If your 401(k) plan invests in the sponsoring employer’s stock, consider the tax consequences of a rollover. If you roll-over the entire balance into an IRA, future withdrawals will be taxed at ordinary income tax rates. But if you leave the funds in your 401(k), you may have an opportunity to take advantage of favorable long-term capital gains tax rates.
Special rules allow you to spin off the company stock into a taxable account. (The remaining balance can then be rolled over into an IRA.) You’ll immediately owe ordinary income taxes on the stock’s tax basis. However, all past and future appreciation will be treated as a long-term capital gain when you sell the stock. Whether this strategy is right for you depends on the amount of appreciation, your tax bracket and your ability to pay the initial tax bill.
Take your time
When you retire or otherwise leave a job, there’s no need to immediately withdraw your 401(k) plan funds. Take the time to review your options and consult your tax advisor before taking action.
Richard M. Homan, CPA, CFP®
As a Hancock & Dana shareholder, Richard brings more than 30 years of regional and local CPA firm experience. His CPA expertise includes individual and business income tax compliance and planning, estate tax planning, small business consulting, and physician practice and compensation consulting. He also provides retirement plan administration and plan design services. In addition to holding a CPA license, Richard is a Certified Financial Planner™ and is a wealth advisor with Homan Wealth Advisors, LLC, a Registered Investment Advisor. http://www.homanwealthadvisors.com/