Since moving your lifetime savings from a company retirement plan could have more future impact than any other financial decision you will ever make, and you only get one chance to do it, it is extremely important to consider all your options. What’s best? What information could I be missing? In the first article of this series, I explained that Life Planning is centered on the questions that you don’t know to ask that need to be answered. Did you know each option available to retirees in regard to their retirement plan has significant implications for taxes, investment growth, and estate planning? Moreover, there is a distinct complexity involved with each individual’s unique situation and these options. There are too many choices to discuss in this short column; however, I would like to address a few of the most common issues we face with our clients.

The majority of retirees and job-switchers will benefit the most by rolling their money directly into an IRA. First, this option is often the most tax advantageous – all federal income tax is deferred until you begin withdrawals from the IRA. Second, because most company plans offer only a handful of investment choices, you are allowed more flexibility in investment options, and the possibility for better returns as a result. Your financial advisor can help you determine the investment options best suited for your situation and goals. Last, there are more options for beneficiaries. Many companies force heirs to withdraw plan balances over a very short time period and can cause severe tax consequences. When and if IRAs are properly titled and transferred, beneficiaries can stretch their required minimum distributions over their lifetime. This allows the subsequent income taxes to be stretched over their lifetime and the account to continue to grow tax-deferred.

Another issue we have discovered in recent years is there are more and more individuals who wish to retire early. Yet if you are not 59 ½ and find that you need money from your 401(k) plan, you may face a 10% penalty. Rolling your 401(k) to an IRA and applying the substantially equal periodic payments rule can pardon this penalty. The rule allows the owner of the IRA to withdraw a specific sum each year until he/she reaches age 59 ½ or over a period of five years, whichever is longer, or by using an IRS-approved calculation method. On the other hand… if you retire from your company after age 55, a provision in the tax code allows you to withdraw money directly from the company plan without paying a penalty. This rule does not apply to withdrawals from IRAs. As confusing as this might sound, it only emphasizes how important it is to work with a Life Planner to determine your best options.

If you work for a large company, there is a good chance you own company stock in your retirement plan. If the stocks’ value has risen significantly over the years, there is a tax provision that might be able to help you reduce capital gains: by moving the stock from the retirement plan into a non-retirement brokerage account, the tax will be based on the price of the stock when it was purchased for the account, not current market value. This opportunity is lost if the retirement plan is rolled into an IRA. However, the odds must be weighed – income taxes will be owed on the stock taken from the retirement plan and withdrawals before age 59 ½ may incur the 10% penalty.

When you retire or switch jobs, you basically have three options to handle your retirement plan distribution. I would like to bring to your attention the 3 worst things you could do:

1. The first option we discussed was rolling your money directly into an IRA. The key word is ‘directly.’ This is not the same option as taking your retirement distribution in cash and rolling it over to an IRA or a new employer’s plan within 60 days of receiving the cash. If you chose the latter, a 20% withholding tax will apply to this lump sum because you have taken possession of it. Additionally, the distributions you take from your IRA will still be subject to income tax.
2. The other option you will have is to take your distribution in cash. Choosing this option will not only lose you the benefit of tax-deferred growth within an IRA, but will cause the full amount to be taxed as income tax in a single year. 20% of your distribution will be withheld and applied toward your income tax for the year.
3. The last, but certainly not the least, worst thing you could do is trying to decide what to do on your own. Remember, you only get one chance to get it right. It is what you don’t know that you don’t know that will hurt you the most. I always tell my clients, “I have not lived your Life on my own; however, I have lived it through the lives of our clients.” Learn from others’ experiences.

 
As with all areas of Life Planning, it is important to find someone who will ask specific questions about your retirement goals and help you design a roadmap to fit your unique situation.