There will come a time when you have to start pondering over when and how to withdraw money from your work-related 401(k). If your employer’s pension plan administrators have invested the money in the plan soundly and have an excellent return on investment (ROI), you probably want to leave the money in there as long as possible. However, you will eventually have to retire from your job and cannot forever keep your retirement savings in your employer’s account. Better consider your options early on so you can make informed decisions when the time is right.
There are various options available to you with regards of your 401(k) when you hit 55 years old. If you have at least $5,000 in the plan, you may decide to leave the money in the 401(k) until the normal retirement age (generally 65 years) or if you will turn 55 during the year, you can also start withdrawing money, although you will be taxed. You will, however, not have to pay any penalties to the IRS.
You have the option to roll over the money to your IRA (Investment Retirement Account). This can help you avoid the annual fees of two plans by combining your 401(k) with your IRA. Also, once rolled over to your IRA, the money can be invested according to your strategies rather than you having to rely on the investment strategies made by the pension plan administrators hired by your employer. If you do transfer the money to your IRA, you will lose some withdrawal flexibility as you no longer will be eligible to withdraw penalty-free till you turn at least 59 and a half years old.
Have you decided to transfer your 401(k) retirement investment to your IRA? Be careful how you go about the transaction because if it is not done properly, you may be on the hook for additional penalties and income taxes.
The simplest method to conserve the tax deferral status of your investment is to transfer the money from your 401(k) directly to your IRA, whether it is an investment broker, life insurance company, mutual fund, or a self-directed investment account.
Avoid the mistake of having the money being paid out to you personally (with the intention of transferring it to your IRA), as your employer is obliged by the IRA to withhold 20% of the balance of the funds for income taxes. The 20% must be held regardless of your plan to rollover the money to your IRA within the 60-day time limit (after withdrawing the money from your 401(k).
Any amount which you do not transfer to an IRA within the allotted timeframe, including the amount withheld by the your employer, will be viewed as a withdrawal of your 401(k) retirement savings and is subject to income taxes as well as a 10% penalty if your age is under 55 years.
This implies you have to come up with the 20% withheld by the employer for the IRS on your own dime. Depending on the value of your 401(k), this can be a substantial amount and might be difficult to come up within the 60-day rollover limit.
To avoid the above problems, simply ask your 401(k) plan administrators to transfer the money directly to your IRA or to issue a check made out to your IRA account, rather than in your name.
Work-related 401(k) accounts often include common shares of your employer and transferring the stock, especially if it has incurred a substantial gain, to an IRA is not be the best retirement tax strategy, as you may end up paying considerably more in taxes when withdrawing the money from your IRA.
You can take advantage of special rules for this type of situation to avoid high tax rates upon selling your company stocks. The rules are for net unrealized appreciation (NUA) of stock and can provide a significantly lower tax bill.
At the time you decide to roll over your 401(k) to an IRA, you have an option to transfer the company shares to a taxable account and the remaining assets to your IRA. In this situation, you will only have to pay income tax on the cost of the shares (the initial price when the share were acquired), rather than on the current market value of the stock. The accrued capital gains, NUA, will only be taxed when you sell the stock.
An added advantage if you select this option is the gain on the sale of such shares is eligible to be taxed at the long-term capital gain rate, which is a lot more favorable than the regular capital gain tax rate. Conversely, if you transfer all your 401(k) assets to your IRA, the money you take of the IRA will be taxed at your top rate at the time of withdrawal, including the profit which you will make on the sale of company stock.
The rollover rules of a 401(k) are simple to explain, yet there are many intricate details one has to be aware of when making the transaction. Ensure you talk to your retirement investment manager to ensure you are taking all the correct steps, based on your personal circumstances.
East West Accounting Services LLC