How To Protect Your 401(k) Money
According to the Investment Company Institute’s 2024 Fact Book, an astounding $10.5 trillion is held in tax-qualified defined contribution plans, such as 401(k) plans. That resource will play an enormous role in the retirement security of millions of Americans over the coming years. Accumulating money in a 401(k) is one thing—arrange for salary reductions to fund the plan, evaluate investment choices for the money, check on progress periodically and make adjustments as needed.
Distribution of 401(k) money is another thing entirely—one that raises a host of new and, for most people, unfamiliar issues. Care must be taken to preserve that retirement resource, typically through a rollover to an IRA. The Fact Book reports that IRA assets have reached some $13.6 trillion. That figure includes contributions to traditional and Roth IRAs, as well as employer-sponsored programs built on IRAs, such as SEP IRAs and SIMPLE IRAs, but the bulk of the funding has come from rollovers.
Will you be receiving a lump sum distribution of some or all of your retirement benefits when you retire? A lump sum distribution, from a 401(k) plan or another qualified retirement plan provided by your employer, can be rolled over into an IRA, preserving its special tax status well into your retirement. However, you will have many important choices to make during this process. It’s not a hard or complicated process, exactly, but the consequences of your choices will last for the rest of your life, so make them carefully.
Employers provide their employees with explanations of their distribution choices, explanations that follow and IRS-approved template. The IRS-provided notices have been criticized for being overly complicated, so much so that Congress ordered the GAO to study the issue. The GAO reported in May that its survey of over 1,000 401(k) participants revealed that only 20% of them knew their four choices for a plan distribution, and 40% did not understand the tax consequences of the choices. The report is at https://www.gao.gov/assets/gao-24-107167.pdf.
On this question, one size definitely does not fit all. What are your retirement income sources? Will your income taxes be going down in retirement? Are you satisfied with the investment options in your employer’s plan? Do you have debts that should be paid off before retirement? How will you invest the money after the distribution?
Preserve the Tax Deferral
Most people will opt to roll their lump sums into an IRA in order to avoid current income taxation. There is a wrong way and a right way to handle this.
The wrong way is to accept a check for the amount of the lump sum. If you take this approach, your employer will be required to withhold 20% in income taxes on the distribution. You’ll either have to be satisfied with an 80% rollover, or you’ll have to come up with the difference from other savings sources.
The right way is to arrange a direct transfer from the qualified plan trustee to the trustee of your IRA rollover—there is no withholding requirement with this approach.
Planning Your Distributions
From age 59 1/2 through age 73 you may withdraw as much or as little from your IRA rollover each year as you please. There’s no penalty tax to worry about, but you will have to pay ordinary income tax on most withdrawals. After you reach age 73, a program of required minimum distributions (RMDs) must begin.
We Can Help
Retirement should be, fundamentally, the moment that you declare your financial independence, a declaration that lasts the rest of your life. Should there be an IRA rollover in this picture? If so, how will the assets be invested? We’ll be pleased to offer you our assistance with these important financial planning issues.
We look forward to meeting with you soon to discuss your needs.
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