REGION – Are you leaving your job and considering whether to take a distribution from your 401(k), 403(b), or governmental 457(b) plan? If so, make sure you’ve considered all your options.
In general, you have the following four options when you’re eligible to receive a distribution from your employer retirement savings plan.
Option 1: Leave the money in the plan
This is the easiest option – you don’t do anything at all. You will have continued tax-deferred growth – or potentially tax-free growth in the case of Roth accounts. While IRAs typically provide more investment choices than an employer plan, there may be certain investment opportunities in your particular plan that you can’t replicate with an IRA. You can receive penalty-free distributions as early as age 55 compared with age 59.5 for IRAs and qualified plans generally provide greater creditor protection than IRAs.
This may not be an option if your vested plan balance is $5,000 or less; if you’ve reached your plan’s normal retirement age; or if the payment is a required minimum distribution. Consult your plan’s terms.
Option 2: No rollover – take the distribution in cash
Most plans allow you to take a lump-sum distribution of your account balance, but this defeats the primary purpose of your plan, which is saving money for retirement. You risk not having enough money at retirement to cover your expenses. All or part of your distribution may be subject to federal – and possibly state – taxes, and the taxable portion may be subject to an additional 10 percent early distribution penalty tax if you haven’t reached age 55. This may significantly reduce the amount you’ll actually receive. You’ll also lose the benefit of continued tax-deferred or tax-free growth.
If your distribution includes employer stock or other securities, special tax rules may apply that can make taking a distribution more advantageous than making a rollover. Consult a tax professional.
Option 3: Roll the funds over to an IRA
Distributions from designated Roth accounts can be rolled over only to a Roth IRA; distributions of non-Roth funds can be made to a traditional IRA or “converted” to a Roth IRA. You will have continued tax-deferred or tax-free growth and generally more investment choices with an IRA than with an employer plan. You can freely move your money among the various investments offered by your IRA trustee and you can freely move your IRA dollars among different IRA trustees/custodians using direct transfers.
With an IRA, the timing and amount of distributions are generally at your discretion; however you must start taking required minimum distributions from traditional IRAs at age 70.5.
No required distributions must be made from Roth IRAs during your lifetime.
Option 4: Roll the funds over to your new employer’s plan
This option has all of the advantages of Option 1, above. You can consolidate your employer plan retirement savings. You may be eligible for a plan loan, and you may be able to delay required distributions beyond age 70.5
One of the most common questions people ask is “Should I roll over my retirement money to an IRA or to another employer’s retirement plan?”
Assuming both options are available to you, there is no right or wrong answer to this question. There are strong arguments to be made on both sides. You need to weigh all of the factors and make a decision based on your own needs and priorities.
When evaluating whether to initiate a rollover, always be sure to:
- Ask about possible surrender charges that may be imposed by your existing employer plan, or new surrender charges that your IRA or new plan may impose.
- Compare investment fees and expenses charged by your IRA or new plan with those charged by your existing employer plan.
- Understand any accumulated rights or guarantees that you may be giving up by transferring funds out of your employer plan.
It is best to have a professional assist you with this because the decision you make may have significant consequences both now and in the future.
Keep in mind that you don’t have to roll over your entire distribution. You can roll over whatever portion you wish. If you roll over only part of a distribution that includes taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.
Written by Huntley Financial Services. For more information, contact Mark Huntley at 888-922-1035.