Retirement Investment Strategies: Navigating Your 401(K) Options

When it comes to investing your 401(k) for retirement, there are several options to consider. Leaving your money in your 401(k) is one option, especially if you like the structure of your plan and want to continue investing in stocks, bonds, or mutual funds. However, it's important to note that you won't be able to make new contributions to this plan once you retire, and you'll still need to pay plan fees. Another option is to transfer your 401(k) to an Individual Retirement Account (IRA), which offers more investment options and lower fees. If you want to continue making contributions, you can consider a Roth IRA, but the money you put in will be taxed upfront. Converting your 401(k) into an annuity is another option that provides a guaranteed income stream, although it may not keep up with inflation. Lastly, you can choose to withdraw a lump sum from your 401(k), but this option may trigger heavy taxes and penalties, especially if you're under 59 1/2 years old.

Leaving your 401(k) with your former employer

• Investment Options and Fees:
• Early Access to Retirement Savings:

If you leave your job in or after the year you turn 55, you may need to withdraw savings from your retirement account before the typical penalty-free withdrawal age of 59 1/2. In this case, leaving your 401(k) with your former employer can be advantageous due to the "Rule of 55." This rule allows you to make penalty-free withdrawals from your 401(k) without incurring the usual 10% early withdrawal penalty, although you will still owe ordinary income tax on the withdrawn amount.

Stable Value Funds:

If you are nearing retirement and seeking a more conservative investment strategy, you may want to maintain your 401(k) with your former employer. Most 401(k) plans offer stable value funds, which aim to preserve the principal by investing in fixed-income securities and insurance company contracts. These "insurance-wrapped bond funds" are typically not available outside of 401(k) plans and can provide a stable, competitive yield.

Downsides and Considerations:

While leaving your 401(k) with your former employer has its advantages, there are some potential downsides to consider:

• You will not be able to make new contributions to the plan once you leave your job, limiting your ability to maximize compounded growth.
• You may be charged higher annual maintenance fees as a former employee.
• You will lose the ability to borrow from your 401(k), which some employers allow for current employees.
• There is no pressure to decide immediately, as you can leave your 401(k) with your former employer and roll it over to another account at any point in the future.

Before making a decision, be sure to carefully consider all your options and consult a financial professional to understand the implications of each choice.

Rolling your 401(k) into an IRA

When you retire, you have several options for what to do with the money in your 401(k) plan. You can generally maintain your 401(k) with your former employer or roll it over into an individual retirement account (IRA). IRAs typically offer a wider selection of investment options than 401(k) plans and can provide thousands of investment choices, including a full gamut of individual securities, mutual funds, bonds, and exchange-traded funds.

Benefits of Rolling Over to an IRA

Rolling over your 401(k) to an IRA can be a smart idea if your 401(k) charges high plan fees or you have several retirement accounts that you want to consolidate and streamline. IRAs often have lower fees than 401(k) plans, and you may have more investment options. Plus, you'll still have the benefit of tax-deferred growth.

Types of IRAs

There are two main types of IRAs to consider when rolling over your 401(k): Traditional IRAs and Roth IRAs.

Traditional IRA

A Traditional IRA is a tax-deferred retirement account. Rolling over your 401(k) to a Traditional IRA may give you more flexibility in managing your savings. Your money can continue to grow tax-deferred, and you may have access to investment choices that are not available in your former employer's 401(k) or a new employer's plan.

Roth IRA

A Roth IRA can be a good option if you're transitioning to a new job or heading into retirement and want to continue saving for retirement while letting any earnings grow tax-free. You can roll Roth 401(k) contributions and earnings directly into a Roth IRA tax-free. Any additional contributions and earnings can also grow tax-free. You are not required to take required minimum distributions (RMDs) with a Roth IRA, and you may have more investment choices than with your former employer's 401(k).

Important Considerations

There are a few important considerations to keep in mind when deciding whether to roll over your 401(k) to an IRA:

• Tax implications: If you roll over pre-tax 401(k) funds into a Traditional IRA, you may not be able to roll those funds back into an employer-sponsored retirement plan. Additionally, if you roll pre-tax assets into a Roth IRA, you will owe taxes on those funds.
• Fees and expenses: Compare the fees and expenses of your 401(k) plan with those of potential IRAs. In some cases, your former employer may have negotiated low fees, especially if they are a large company.
• Investment choices: Evaluate the investment options available in your 401(k) plan and potential IRAs. If you are happy with the investments provided by your 401(k), there may be no reason to switch.
• Required minimum distributions (RMDs): RMDs may be delayed beyond age 73 if you're still working and have a 401(k). However, RMDs are required from Traditional IRAs, regardless of whether you are still working.
• Company stock: If you hold stock in your former employer in your 401(k), there may be special tax or financial planning needs to consider before rolling over your assets to an IRA.

How to Roll Over Your 401(k) to an IRA

There are a few ways to roll over your 401(k) to an IRA:

• Direct rollover: Ask your plan administrator to make the payment directly from your 401(k) to an IRA. No taxes will be withheld from your transfer amount.
• Trustee-to-trustee transfer: If you have an IRA, ask the financial institution holding your IRA to make the payment directly from your IRA to another IRA or retirement plan. No taxes will be withheld from your transfer amount.
• 60-day rollover: If a distribution from your 401(k) is paid directly to you, you can deposit all or a portion of it into an IRA or a new retirement plan within 60 days. Taxes will be withheld from a distribution from a 401(k), so you'll need to use other funds to roll over the full amount.

Remember to carefully consider all your options and the applicable fees and features of each before deciding to roll over your 401(k) to an IRA.

Withdrawing a lump sum from your 401(k)

If you decide to withdraw a lump sum from your 401(k), you can simply instruct your plan administrator to cut you a check. You are then free to use the funds as you see fit. However, cashing out your 401(k) can significantly reduce your retirement savings, and you will face an immediate tax bill. You will have to pay federal (and possibly state) income tax on the withdrawn amount, and you may be pushed into a higher tax bracket. Your employer is also required to withhold 20% of your distribution for federal taxes, so the amount of cash you receive may be less than expected.

A lump-sum distribution from a 401(k) can provide access to a large sum of money, which can be useful for major purchases or investments. However, it is important to carefully consider the tax implications and potential penalties before making this decision.

To avoid the 10% early withdrawal penalty, you may want to consider other options, such as leaving the funds in your 401(k) to continue tax-deferred growth, rolling over the funds into an Individual Retirement Account (IRA), or setting up periodic withdrawals.

Converting your 401(k) into an annuity

A direct transfer is a more straightforward approach. It is handled almost entirely by the financial institutions managing your money. You will need to fill out some forms and provide your authorisation for the transaction.

With a qualifying withdrawal, you take possession of the liquidated retirement funds (in some cases, net of an automatic 20% IRS withholding). Then, to avoid tax complications, you must put the gross amount of the withdrawal into an annuity within 60 days of receipt. Finally, you can recover any funds withheld by the IRS when filing your taxes.

Annuities can be a good option if you want a guaranteed income stream in your retirement. However, they may have drawbacks such as charges and fees, and in some cases, no death benefit for your beneficiaries.

Since your 401(k) is already tax-deferred, there is no additional tax advantage to buying an annuity with your rollover.

There may be benefits to leaving your money in your 401(k) plan. These include:

• Continuing to benefit from tax deferral.
• Having access to unique investment options.
• Lower fees and expenses.
• The possibility of loans.
• Distributions are 10% federal tax penalty-free if you terminate service after turning 55.

Additionally, if you intend to spend a substantial amount of your savings early, an annuity might not be a good fit. The surrender periods and long-term nature of annuity strategies are better suited for those who leave the majority of their money in an annuity for an extended period.

Taking required minimum distributions at age 72 or 73

When it comes to your retirement, there are a number of options for what to do with your 401(k) savings. One option is to take required minimum distributions (RMDs) at age 72 or 73, depending on when you were born. Here is some detailed information on taking RMDs at this age:

RMDs are the minimum amounts that you must withdraw from your retirement accounts each year. The age for withdrawing from retirement accounts was increased from 70.5 to 72 in 2020. The SECURE 2.0 Act has now raised the age for RMDs to 73 for those who turned 72 in 2023. The RMD age will eventually increase to 75 for anyone who turns 74 after 31 December 2032.

RMDs apply to most retirement plans, including 401(k) and 403(b) plans, and small business accounts. They do not apply to Roth IRAs and Roth 401(k)s, as contributions to these accounts are made with after-tax dollars. However, RMDs do apply to inherited IRAs.

The amount you must withdraw depends on the balance in your account and your life expectancy as defined by the IRS. The IRS provides Uniform Lifetime Tables to help you calculate your RMD. You can also use an IRS RMD worksheet or an online RMD calculator.

You generally must start taking RMDs by 1 April of the year after you turn 73. For each year after that, you must withdraw your RMD by 31 December. There are penalties for not taking RMDs or for taking less than the minimum amount.

If you are still working at the company that sponsors your 401(k) plan, you can delay taking RMDs until after you retire, as long as you do not own 5% or more of the company. If you are an account owner in a workplace retirement plan, you can delay taking RMDs until the year you retire, unless you are a 5% owner of the business sponsoring the plan.

Frequently asked questions