Steve Coker has been a certified financial planner for 16 years. He earned an MBA from UCLA and has an office in Westlake Village.
Retirement should not be stressful, but too often, it is. A flurry of critical decisions accompanies this significant life change, and it’s enough to give even the most careful retiree a headache.
Of course, education is the best medicine for the unknown. To help ease the frustration — and possibly the financial pinch — of retirement, let’s walk through one of the most basic retiree questions of all: “What should I do with my 401(k) when I retire?”
For most retirees, the correct answer is to roll over their 401(k) to an IRA, an Individual Retirement Account. As the name implies, an IRA is a retirement account under your full ownership and control, while a company’s 401(k) plan is run by your former employer. The first advantage of an IRA is straightforward: having one will allow you to access your funds more easily without going through a corporate benefits department. After all, it’s your money. Why leave it behind at your company when you retire?
An IRA can have other benefits as well,increasing your investment choices and lowering your fees compared to most 401(k) plans. But there are scenarios when you want to keep your 401(k) rather than rolling the funds to an IRA. For example, if you are retiring before age 59.5, it may make sense to keep your 401(k). Remember that taking distributions from retirement accounts before age 59.5 generally results in a ten percent penalty. There are several exceptions to this general rule, and one of the best applies only to 401(k) plans. If you are 55 or older when you retire, you may be able to take distributions from your 401(k) plan without penalty. Rolling over your 401(k) to an IRA will result in losing this one exception. (If you have rolled over your 401(k) already, do not despair! Other exceptions apply to IRAs).
Be careful to make this transition from 401(k) to IRA correctly. It is essential to execute a “direct rollover” which moves the money from one retirement plan directly to another plan without being distributed to you. It is a non-taxable event. A rollover is different from distributing or paying the 401(k) balance to yourself, which results in a massive tax bill. It is crucial to understand this distinction, unless you like giving Uncle Sam more of your hard-earned money.
Sometimes, a 401(k) will have both pre-tax contributions and post-tax (also known as “Roth”) contributions. If so, be sure 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 401(k), request that two separate checks be sent, one for the pre-tax funds and one for the post-tax funds. Pre-tax funds will be rolled over directly into a traditional IRA, and post-tax funds will be rolled over directly into a Roth IRA. If you do have post-tax contributions in your 401(k), then good for you. These funds have already been taxed, so they will continue to grow tax-free in your Roth IRA and can be withdrawn tax-free in the future.
Of course, everyone’s situation is different. Talk with your financial advisor or tax professional to understand what is best for you. But whatever you do, do it in an informed way to avoid any unnecessary headaches as you head into the next wonderful season of life.
