One of the reasons investing gets confusing for most people is that there are too many rules, requirements, products/options, and terms. The website “Investopedia” claims to have a “comprehensive financial dictionary with over 13,000 terms and counting.” Insanity!
The world of retirement planning – which is just a subset of investing – is not much better. But the definitions do matter. A 401(k) withdrawal, for example, could mean paying penalties and taxes that could cost you dearly if done wrong, or done at the wrong time. A 401(k) rollover, on the other hand, could provide you with several benefits and advantages for moving your retirement plan in the right direction.
In this case, a single word makes all the difference – and not knowing it could cost you.
What is a 401(k) Withdrawal, and When Should I Take One?
Generally speaking, it’s a pretty safe baseline assumption that you should not make a 401(k) withdrawal until you turn 59½. Period.
If you’re younger than 59½, basically the only qualifying event that would enable you to make a distribution is a hardship of some kind, such as an immediate and heavy financial need, qualifying medical expenses, or a qualifying disability. Another potential scenario would be if you took distributions as part of a “series of substantially equal periodic payments” that started after you left a company and continued at least annually for the rest of your life/life expectancy. While that’s an option, it should probably only be considered in rare cases – after all, generally speaking, systematically taking money out of retirement accounts should only be something fully retired people do.
In short: assuming you’re in good health, and that you still have financial resources of some kind available to you, then a 401(k) withdrawal before 59½ is pretty much off the table. Taking a withdrawal anyway could mean incurring a 10% penalty in addition to the taxes you have to pay on the amount withdrawn. You worked too hard to let that happen.
After you reach the retirement age of 59½, you can generally begin making distributions without having to pay any early withdrawal penalties. If you don’t want to make withdrawals at retirement age, that’s ok too, but you may be forced to by the time you reach age 70½ (because of required minimum distribution rules).
What is a 401(k) Rollover, and When Should I Do One?
A 401(k) rollover is entirely different from a withdrawal, because in a rollover the money is staying inside of a retirement plan or a retirement account –it’s not going to you directly for personal use. A rollover occurs when you take a distribution of cash or other assets from one qualified retirement plan and move all or part of it to another qualified plan or traditional IRA within 60 days. Rolling over a 401(k) is not a taxable event but you do however have to report it on Form 1099-R, which is a simple IRS form to file. We know – again with the rules and restrictions!
Sorry, but here are just a few more rules for you. It is not possible to roll over a 401(k) while you’re still working at the employer who is sponsoring it. To roll it over, you must either leave the employer (or be terminated from employment), or the 401(k) plan must be terminated at your employer with no successor plan or other retirement option made available in its absence.
People move jobs often these days, so the possibility of rolling over a 401(k) comes up quite a bit. When you switch jobs, you can usually keep your 401(k) at the plan administrator/custodian of your old employer, but it may make sense to roll it over instead. While each situation is different, here are a few potential reasons why:
- Expanded Investment Options – Many 401(k) plans offer just a few investment options, usually categorized by risk, target retirement date or asset class. While these may have served you well during the bulk of your years of saving, they might not be able to offer you all the choices you need as you begin your retirement years. Making your money stretch through retirement may require investment strategies that just don't work with your existing 401(k).
- More Flexibility -- Some 401(k) plans require that you invest a certain percentage of your funds in company stock, and this can lead to over-weighted positions in your portfolio.
- Consolidation of Your Accounts – monitoring your portfolio can be tricky if your investments have become spread out over time. Consolidating them into a smaller number of accounts in fewer locations can help you and your Financial Adviser better see and understand your entire financial picture.
- IRA Beneficiary Options – Different 401(k) plans have different rules, but if you find that your plan limits your beneficiary options, you may be able to overcome this by rolling the assets into your IRA.
- Estate Planning Options – Many investors want to pass their assets to future generations. One way to do this is with the Stretch IRA strategy which can help your assets grow and last over multiple generations. A 401(k) rollover makes this option a possibility.
Don’t Make a 401(k) Mistake – Ask WrapManager for Advice First
Working with an advisor can help you navigate the myriad investment choices and help you avoid penalties and mistakes. In the world of 401(k)s, there are many “do’s” and “don’ts,” and the “don’ts” usually come with penalties and unwanted tax bills. Working with a WealthManager at WrapManager can help you know your options so you can make the choice that’s financially sound for today and the future.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.