Whether you are planning to retire soon or just beginning a new job, determining what to do with your retirement-plan account can make a world of difference in your financial future.
Now, more than ever, we are becoming increasingly responsible for funding our own retirement. More Americans today have multiple employers in their lives, and 401(k) and other company-sponsored retirement plans are becoming a critical piece in the retirement-funding puzzle.
Whether you are planning to retire soon or just beginning a new job, determining what to do with your retirement-plan account can make a world of difference in your financial future. With so many options available, deciding what to do may seem like a daunting task.
- Should you roll your money into an IRA rollover account?
- What are the consequences of taking a cash distribution?
- How can an IRA rollover account be tailored to suit your retirement needs?
Keep in mind, however, that your former employer will retain responsibility for investments, and the plan may not have the investment options or distribution flexibility you desire. In addition, you will have to contact your former employer with any address changes or other information that may be relevant to your account.Option 2 —Keep/spend your distributionSixty-eight percent of plan participants who changed jobs in 1999 took cash withdrawals from their tax-deferred retirement plan accounts, rather than leaving their money in the plan or rolling their balances into their new employer's plan or into IRAs. The highest percent of cash payments, 78 percent, occurred among 20- to 29-year-old investors, according to March 2000 Money magazine. Because of the potential taxes and penalty involved in taking a cash withdrawal, this action could amount to willingly giving up money you have worked hard to save and invest.
Receiving a lump sum of money may seem appealing, but it comes with a price. If you choose to keep/spend your distribution, the Internal Revenue Service automatically withholds 20 percent of your distribution.
You also will be subject to federal and state income taxes on the amount not rolled over, in addition to a 10 percent penalty for early withdrawal if you are under age 55 when you retire or terminate service. For many investors, it just isn't worth it. Investors who spend their distribution have lost many years of tax-deferred compounding that could have made a significant difference in their retirement nest egg.Option 3 —Receive your distribution and deposit it into an IRA rolloverIf you receive your distribution from your qualified retirement plan and the funds are made payable to you, your check will be missing an immediate 20 percent tax withholding paid to the IRS, even if you decide to roll it over into an IRA. If you deposit your distribution check into an IRA rollover, this shortfall must be made up from your own pocket to fulfill the entire rollover amount. Otherwise, the 20 percent amount withheld will be subject to federal and state income taxes and possibly penalty taxes.
For example, if your distribution amount is $100,000, the 20 percent mandatory withholding will be $20,000, and you will receive $80,000. You have 60 days to roll over the amount distributed to you, which means $20,000 must come from your pocket to ensure that the entire $100,000 is rolled over, or the $20,000 becomes taxable and potentially subject to the 10 percent penalty.Option 4 —Transfer your distribution directly into an IRA rolloverDirect IRA rollovers have been designed to help you invest for your retirement future while paying no income taxes on your retirement savings today. When an IRA rollover account is set up and the entire distribution is transferred directly into the account, you receive these benefits:
- You will avoid the 20 percent tax withholding and early withdrawal penalties.
- You can defer income taxes on the distribution until you make withdrawals.
- You can decide where to invest your money as permitted by the IRA rollover.
In addition, the earnings on your assets will continue to grow tax-deferred until they are withdrawn.
Other advantages of IRA rollovers
Payout flexibility. If you are between the ages of 59½ and 70½, you can withdraw what you need from your IRA rollover account at any time without penalty. After age 70½, current tax laws require you to make minimum withdrawals based on life-expectancy tables developed by the Treasury Department. You also have the advantage of receiving extra money from your account when you need it for that remodeling project, special trip, or just to cover unexpected expenses.
Pay no penalty taxes on preretirement life-expectancy withdrawals. You can even establish an IRS-approved equal payment plan at any age and avoid the withdrawal penalties.
Pay no current tax on your distribution or earnings. Once you become eligible for distribution, keeping the entire amount, including all earnings, in an account will ensure that your money continues to work for you — tax-deferred — until you need it. This is usually during your retirement years when you may be in a lower tax bracket. Even if you will be in the same or a higher tax bracket, you may still benefit by allowing your retirement assets to compound in a tax-deferred account until they are withdrawn.
Don't mortgage your future by spending your retirement dollars today!
Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.