For most people planning their retirement, 401k plans are an important part of their financial toolbox. These accounts are considered the modern-day version of traditional pension plans, and most employers offer matching contributions to help their employees save for retirement.
If you’ve opened a 401k account with your employer or are planning to do so, it’s helpful to understand the best and worst moves you can make. Let’s look at what these are.
What you SHOULD do
Here are the best moves to include in your 401k withdrawal strategy, to save taxes and maximize your retirement income:
- Rolling over to an IRA or a self-directed 401k – When you change jobs, rollover your 401k money into an IRA or401k. IRAs and self-directed 401ks offer a much wider range of investment choices than 401k accounts, and investment fees are typically lower as well. They also allow you to choose other beneficiaries than just your spouse.
- Converting to a Roth 401k – Convert your traditional 401k into a Roth 401k, for better post-retirement benefits. Roth 401ks are funded with post-tax dollars, but qualified withdrawals and earnings are tax-free. At 71 ½ when Required Minimum Distributions (RMDs) come into play, you will rollover the Roth 401k to a Roth IRA. The Roth IRA does not attract RMD’s. IMP.
- Taking distributions early – Take distributions before you actually need them, but only if you can resist the urge to spend instead of investing the money. Ideally, make 401k withdrawals before you start receiving Social Security or other retirement income and move into a higher tax bracket.
- Do your homework – Learn about retirement tax brackets, RMD requirements and early withdrawal penalties, so you can leverage these to your advantage. For instance, most people expect to be in a higher tax bracket by the time they retire, so investing in Roth IRA or 401k accounts could help you reduce taxes later.
What NOT to Do
Here are some moves that won’t help your 401k withdrawal strategy:
- Not making withdrawals – Leaving money in your 401k account may seem like a good idea, but you need to keep track of RMDs to avoid penalties as well. Typically, you need to start making withdrawals starting at the age of 70½, but you can reduce the 401k amount that’s subject to RMDs if you start taking money at the age of 59½ and using it for investments not subject to RMD’s.
- Taking the funds out – Cashing out your 401k isn’t the best idea either, since you will be subject to a heavy income tax bill if you take distributions before the age of 59½. You will face an early withdrawal penalty of 10% on the withdrawal amount PLUS income tax., In addition you will lose out on the interest you could have earned by leaving the money in the account!
- Not checking 401k costs – Rolling over to a new employer’s 401k without first checking the cost of investments and brokerage fees is a bad idea. You could always choose the option of opening a low-cost IRA for these retirement funds if the fees for the new employer’s 401k are higher than those for your old account.
- Handling funds in your name – Taking a check in your name for the rollover is also a bad move. Request a direct transfer into the new 401k/IRA, or a check made out to the account’s custodian instead. Twenty percent of the amount will be withheld as tax if you take a check in your name, refundable only if the rollover is completed within 60 days.
(Featured image by DepositPhotos)
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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