If you have a 401(k) retirement savings plan with your employer, you may believe you have a great vehicle for safely and securely growing your savings as you work slowly toward retirement. It’s true that 401(k) plans can provide good returns for contributors, but there are a few specific steps that you should make sure to take to ensure maximum gains in retirement:
- If Possible, Don’t Leave the Plan Until You’re Fully Vested.Employers’ matching contributions to 401(k) plans are usually not available to individual plan members until the latter are vested in the plan. If you leave your company early or retire before the plan’s vesting date, you can potentially lose thousands of dollars by walking away. Sometimes, it can be only a matter of months, so look at the terms of your plan carefully, and make sure you know all the important dates.
- Don’t Do a Direct Rollover.If you’re rolling over a previous 401(k) into an IRA, ask your last employer to make the check payable or directly transfer the money to your new account’s custodian, rather than to yourself.
If the money is paid to you directly, 20 percent of the account balance will be held for tax purposes. If you don’t deposit the funds in a new tax-deferred account within 60 days, the government keeps the 20 percent portion and there can be still more tax owed. If you’re under the age of 55 when this occurs, there will also likely be a 10-percent early-withdrawal fee on any of the funds not put into a new retirement account.
- Don’t Rollover Into a Higher Investment-Cost Plan.
Often, it may seem attractive to rollover your 401(k) into an IRA because such plans typically have more investment options and lower costs than a 401(k) — but not always!
Some 401(k) plans have particularly low investment fees that were negotiated by the company contributing to the plan. When you retire or change jobs, it pays to look carefully at both the 401(k) and the IRA and see which one offers better rates and options; it may actually make sense to leave the money in your old 401(k), even if you’ve left that job.
- Pay Attention to Distribution Dates.After you turn 70½, you’re required to make a withdrawal from your plan every year. The first year, you need to take it by April 1 of the year after the one that you turned 70½. If you don’t withdraw the correct amount, you must pay 50 percent in excise tax on the proper amount that should have been taken out.
April 1 is the deadline for your first withdrawal. In every year following, the deadline is December 31. This means for the first year you’re eligible, if you wait until April for your first withdrawal, you might potentially make two withdrawals in the same fiscal year. This could possibly affect your income tax rate if you don’t time them well.
- Don’t Withdraw Money Before You Retire…You may be aware of this already, but if you withdraw money from your 401(k) savings account before the age of 59½, you’ll be taxed on the amount withdrawn, and usually, you’ll have to pay a 10 percent early-withdrawal fee. As an example, if you make an early withdrawal of $5,000 from your 401(k) account and you currently fall into a 25 percent tax bracket, you’ll only see $3,250 of that money.
Early withdrawals should always be avoided if you possibly can as they’re extremely costly to you. Experts advise waiting as long as possible before taking money out of a retirement account. If you have no other option, try to take as little money out as possible, so you can avoid the 10 percent fee to the extent you’re able to.
- …Unless You Qualify in One of These Ways.If you’re younger than 59½ and want to withdraw money from your 401(k) without incurring a penalty, ask yourself if you meet any of these conditions:
a. You happen to be in a disaster area as described by the IRS
b. You need to make alimony and/or child support payments
c. You have medical expenses
d. You’re disabled
e. You’ve left your company, and you have a schedule to withdraw payments for more than 5 years, or until the age of 59½, whichever is greater.
If you meet one or several of the above conditions, you may be able to withdraw money from your account without a penalty.
- Use Hardship Withdrawal Rules to Your AdvantageIf you’re rolling your 401(k) money over into an IRA, you may be able to use one of several government-approved options, known as hardship withdrawals, to avoid the early-withdrawal penalty. Hardship withdrawals include spending on unreimbursed medical expenses representing more than 7.5 percent of your total income, health insurance costs after a job loss, college expenses or the purchase of a first home (up to $10,000 in costs).
Funeral expenses and charges relating to repairing or preventing a foreclosure on your home may also qualify. Typically, in such circumstances, you need to show your employer proof of your finances. If you’re interested in these options, talk with your employer more about them.
Regards,
Ethan Warrick
Editor
Wealth Authority
