Retirement should not be stressful, but too often it is. The flurry of critical decisions combined with a dramatic life change is enough to give even the most careful retiree a headache. Of course, we believe that education is the best medicine. To help ease the pain, we will walk through one of the most basic retiree questions of all: “What should I do with my 401k when I retire?”
For most retirees, the right answer is to rollover their 401k to an IRA, which is an “Individual Retirement Account”. As the name implies an IRA is a retirement account that is under your full ownership and control, as opposed to a company’s 401k plan run by your former employer. The first advantage is straightforward – having an IRA will allow you to access your funds more easily without having to go through a corporate benefits department. After all, it is your money, so why leave it behind at your company when you retire. But an IRA can have added benefits, such as increasing your investment choices, and lowering fees compared to most 401k plans.
When moving 401k money to an IRA it is important to execute a ‘direct rollover’. A rollover moves the money from one retirement plan to another and is a non-taxable event. A rollover is different from distributing the 401k balance to yourself which result in a massive tax bill, so it is important to understand this distinction.
Sometimes, a 401k will have both “Pre-tax” contributions and “Post-Tax” (also known as “Roth”) contributions. If so, you will want to keep the Pre-tax and Post-Tax dollars separate. This is easily accomplished by opening two separate IRAs, a “Traditional IRA” for the Pre-Tax funds and a “Roth IRA” for the Post-Tax funds. When rolling over your 401k, you will request two separate checks, one for the Pre-tax and one for the Post-Tax funds. Pre-tax funds will be rolled over into a Traditional IRA and Post-Tax funds will be rolled over into a Roth IRA. If you do have Post-tax contributions in your 401k, then good for you. These funds have already been taxed, will continue to grow tax free in your Roth IRA, and can be withdrawn tax free in the future.
There are a few cases when you would want to keep your 401k rather than rolling over the funds to an IRA. For example, if you are retiring before the age of 59.5 then it may make sense to keep your 401k. Remember that taking distributions from retirement accounts before the age of 59.5 generally results in a 10% penalty. There are several exceptions to this general rule, and one of the best applies only to 401k plans. If you are 55 or older when you retire you may be able to take distributions from your 401k plan without penalty. Rolling over your 401k to an IRA will result in the loss of this one exception. (If you have rolled over 401k already, do not despair! There are other exceptions that apply to IRA’s).
Of course, everyone’s situation is different. If you would like some help navigating the rules, we are here to help you through the retirement process. Simply give us a call.