When you leave your company of employment, you must decide what to do with your retirement plan assets. Knowing what your distribution options are, will have an effect on your retirement savings. This can make the difference between having a comfortable retirement and not having one at all.
Direct Rollover into an IRA
One of the easiest ways to avoid any mandatory state or federal withholding taxes, as well as a possible 10% IRS penalty, is to directly rollover your entire plan into an IRA ( Individual Retirement Account). An IRA is a tax-deferred qualified account that can be used to receive retirement benefits distributed from an employer’s qualified plan. Since all earnings continue to accumulate on a tax-deferred basis, your funds will continue to compound and accumulate more rapidly than money placed in an otherwise identical taxable account. There are several types of IRA's. To find out which type is right for you contact Gemlife Financial.
If you decide to have the funds distributed directly to yourself, instead of a direct transfer, you have 60 days from the date you received your payout to invest these funds into an IRA, along with an additional 20% of your own money to cover the amount withheld. When you file your income tax return, you will receive credit for the 20% withheld. But remember, you only have 60 days to do this. If you fail to act within the 60 days, your entire payout will be subject to state and federal income taxes, a potential 10% premature distribution IRS penalty, and your accumulations tax-deferred status will be lost forever.
Should I take a Taxable Distribution from my 401k?
Although taking a taxable distribution can give you access to the savings in your retirement plan, there are several things to consider when taking a lump-sum distribution:
- Taxes will take a "bite" out of your distribution. Contributions to your 401k are made with pre-tax dollars. In addition, employer contributions to your 401k or qualified plan on your behalf were also tax deferred. Upon distribution, you have to taxes based on your current tax bracket on all pre-tax contributions and earnings.
- A 10% IRS penalty may also apply (also known as a premature distribution penalty). Generally, if you are under age 59 1/2 you will have to pay the IRS an additional 10% penalty when you file your federal income taxes next year. There are certain exceptions to this rule, such as death, disability, or substantially equal payments.
Transfer Funds to Your New Employer's Plan
If your new employer's plan accepts rollovers from another employer's plan, you can transfer the funds directly to its 401(k) plan or other type of qualified employer plan, avoiding current income taxes and the 20% withholding tax.
Keep Funds in Your Old Employer's Plan
For account values of $5,000 or more, you may be able to keep your funds in your former employer's plan. Your funds will continue to accumulate tax-deferred, and can later be moved to a new employer's qualified plan or an IRA. If you are over the plan's retirement age or age 62, your company may insist that you take a payout in order to decrease the plan's administrative costs. If this happens, you still have the option to make a direct rollover to an IRA.
- Did You Know...? The 1974 Employee Retirement Income Security Act, better known as ERISA, protects people's retirement funds in case of job change (or loss).