You’re 54, you’ve been diligent about saving, and are looking forward to retiring soon. Like most people you have the majority of your retirement savings in your employer-sponsored plan – think 401(k) – and you’ll need to use some of these funds between retirement and when Social Security kicks in or you start turning a profit on that business you’ve always wanted to start.
A plan participant leaving an employer typically has four options (and may engage in a combination of these options), each choice offering advantages and disadvantages:
- Keep the funds in the current plan (if you’re permitted under the rules of the plan).
- Rollover to a new employer plan if you have changed jobs – if one is available and rollovers are permitted.
- Cash out.
- Rollover to an IRA.
The first two options are fairly self-explanatory: you remain in an employer-sponsored plan with whatever set investment options are available.
Cashing out is a taxable event (100% of the funds you pull out are taxable at your current rate) and there’s also a 10% penalty if you are under 55.
If you transfer your 401(k) to an IRA, you can continue to defer taxes until distributions take place. However, if you are under age 59½, you may be penalized an extra 10% on withdrawals from an IRA unless you take what are called a Series of Equal Periodic Payments (SEPPs), or 72t payments. The amount that can be taken each year is limited and must be taken over the longer of five years or until you reach age 59½. Once you begin taking these 72t payments, you also lose the ability to take ad hoc withdrawals from the same IRA.
One little known exception to the early withdrawal penalty mentioned above is for those distributions from a 401(k) after you separate from service, as long as you were age 55 or older when your employment at the 401(k) sponsor-company ceased. This means that there is no need for fancy strategies to avoid the 10% penalty, you can take whatever amount you require from your 401(k) at whatever time, and start and stop as your need arises.
This of course may leave you with limited investment options and you may not want to leave all your money in your former company’s plan for one reason or another. Also, there is a required 20% tax withholding on withdrawals from a 401(k). This is where it’s useful to work with a financial advisor who knows that partial transfers can be done, where you can keep a strategic amount of money over at the 401(k) to maintain flexibility of penalty-free withdrawals, and transfer the rest to an IRA.
Ultimately, everyone’s situation is unique, so as you approach retirement, so speaking with a financial professional before making a decision is recommended.