If you’re like many workers, much of your retirement savings may exist inside your company’s 401(k) plan. The 401(k) is one of the most commonly used retirement savings vehicles because it offers tax-deferred growth and, possibly, matching employer contributions. Those two elements can be a powerful combination for retirement asset accumulation.
When you leave your employer, whether it’s because of a job change or retirement, you may face a decision about what to do with your 401(k) balance. Conventional wisdom is that it’s usually wise to roll your balance into an IRA. When you do a rollover, you avoid taxes and penalties, and you may gain access to a wider menu of investment options.
However, a rollover may not always be the right strategy. In many cases a rollover is the appropriate decision, but there could be instances in which you may be best served by keeping your balance in the 401(k) plan.
Below are three such instances. If you might face any of these situations in the future, you may want to consider your options carefully before moving forward.
You may retire before age 59½.
Tax deferral is an important benefit in qualified plans such as 401(k)s and IRAs. Tax deferral means you don’t pay taxes on your investment growth as long as the funds stay inside the account. Instead, you pay income taxes when you take distributions. Essentially, all taxes on your accumulation are deferred until you retire and start taking withdrawals.
However, these accounts are tax-deferred specifically because they are intended for retirement savings. They’re not meant to be used for short-term saving and investing. That means you generally aren’t allowed to take distributions from your qualified accounts until age 59½. If you take a distribution before that point, you may face a 10 percent early distribution penalty.
There are exceptions to this rule, however, including an important one for 401(k) participants. If you leave your employer and stop using the 401(k) after age 55, you can take distributions without paying the penalty. You will still pay taxes on the distributions, but you’ll avoid the early penalty. You may not have the same flexibility with an IRA.
You own company stock in your 401(k).
Have you used your 401(k) to purchase company stock? Company stock is a common investment option in many employer-sponsored plans. Depending on how long you’ve been in the plan, that stock may have accumulated substantially over time.
If you roll your 401(k) into an IRA, your company stock will transfer into the IRA as part of the rollover process. However, you will have to pay income taxes on the full stock value when you later withdraw it from the account.
Instead, you could keep the stock in your 401(k) and distribute it through a process known as net unrealized appreciation. That means you can distribute the stock from the plan and pay income tax on the basis and capital gain taxes on the growth. That could result in a much lower tax bill as compared with a distribution from an IRA.
You may work beyond age 70½.
More and more workers are choosing to work into their late 60s and even their 70s. If you’re one of those workers, you could benefit from keeping your funds in your 401(k). Many qualified plans, with the exception of the Roth IRA, require you to take mandatory distributions starting at age 70½, which can be problematic if you’re still working and don’t need distributions.
There’s an exception to the required minimum distribution rule if you continue to work past age 70½ and are a participant in a 401(k) plan. You aren’t required to take distributions, and you can even keep making contributions and receiving employer matching contributions. If you roll your funds into an IRA, you will be required to take distributions at age 70½, regardless of whether you are still working.
Wondering whether you should keep your funds in a 401(k) or roll them into an IRA? Let’s talk about it. Contact us today at J. Harris Financial. We welcome the opportunity to help you analyze your needs and goals, and then develop a strategy. Let’s connect soon and start the conversation.
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