If you're nearing retirement, it's time to check your 401k (and other investments) to refine your asset allocations. While investing in high- and medium-risk funds was the right thing to do when you had plenty of time until retirement, now is not the time to risk a big drop in value. It's also a good time to consider what type of account you want your money to stay in.
But first, let's talk about when you can start taking money out of your 401k. Once you reach the age of 59 ½, the government says you can begin to withdraw your money penalty free. While there are a few exceptions, if you pull your money out of your 401k prior to age 59 ½, you'll have to pay a 10 percent early withdrawal penalty.
Okay, so you're 59 ½ and you're ready to evaluate your 401k. Here are your options:
Lump sum
This is an option if you need a large sum of cash right away, but you're going to lose a sizeable amount of your money to taxes. Distributions count as income for the year they are taken. So if you withdraw $1 million, you're going to get taxed as if that was your income for the year. If you can, you probably want to avoid taking all of your money out at one time.
Regular distributions
Assuming your plan sponsor (e.g., your employer) allows you to stay in their plan after you retire, you can set up your account to receive regular distributions-like a paycheck. With this option, you'll want to take into account all of your assets and make sure you're not withdrawing too much. Set a budget and make sure you're in good shape all the way through your retirement.
Roll it into an IRA1
Rolling your money over into an IRA (Individual Retirement Account) does not count as a lump-sum distribution, so you don't have to worry about getting hit with a large tax bill. Why roll it over? In most cases, you'll have more fund choices if you're in an IRA, as 401k funds are limited by your employer's plan. If your 401k doesn't have many fund options, it makes this decision much easier. But if you're happy with your 401k, you may want to speak to a financial advisor to determine if a rollover makes sense. For example, if you have more than one retirement account, rolling everything into one IRA may offer you cost efficiencies and save you money in the long run.
Leave it for now
If you're happy with your 401k, you have funds outside of the account to live on, and your employer is allowing you to keep your 401k open, then you also have the option of leaving the money alone for the time being. Tax law allows you to leave your money in a 401k until you're 70 ½. At that point, if you haven't begun taking distributions, well, now you have to.
If you still have five to 10 years until retirement, take that time to set aside extra money into a savings account. As mentioned above, retirement account distributions count towards your annual income, so if you have additional money in places like a high-yield savings or money market account, you can keep your tax rate down and make your retirement account stretch a bit further.
Take the time to sit down with a financial planner to determine which option is best for you, and to ensure your money is sitting in age-appropriate funds. Financial planning for retirement is critical to a happy and stress-free transition into this next exciting phase of your life.
The information mentioned in this article is for informational purposes only, is intended to provide general guidance and does not constitute legal or tax advice. Each person's situation is unique and may materially differ from the information provided herein. You should seek the advice of a financial professional, tax consultant and/or legal counsel to address your specific needs before any financial or other commitments regarding the issues related to your situation are made. Popular Bank does not make any representations or warranties as to the content contained herein and disclaims any and all liability resulting from any use of or reliance on such content.
1. Investment and insurance products available in some Individual Retirement Accounts are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.