So you are retiring early? Congratulations. If you are like many retirees, you have done a great job of saving into your company retirement plan and you now may have a problem…how to access those dollars and avoid any tax penalties.
Be careful not to roll over your 401(k) too early!
Overview of potential penalties: One of the advantages to saving into things like 401(k)s and IRAs is the possible tax deduction on the money going in and then the tax deferral as the accounts grow. However; it is time to start paying Uncle Sam once you retire and start taking money out of those plans. You have to face the fact that if you have not paid any tax on the dollars, you will have to once you start taking the money out. While you will want to reduce your tax rate when possible, you will also want to avoid any tax penalties. A penalty of an extra 10% may be assessed if you take dollars out of your plan too soon.
Why 55 and 59 ½ are important to you: The tax law reads that if you take a distribution from your IRA prior to 59 ½ you may face a stiff 10% penalty. There are ways to avoid it for certain kinds of distributions but for my retirement example let’s say you do not qualify for such exemptions.
The bottom line is that you want to avoid IRA distributions prior to 59 ½.
What many are not aware of is that the age for penalty free distributions from your 401(k) is different.
You may be able to take money out of your 401(k) after you reach age 55 and avoid the 10% penalty! That’s right, the law is written such that you can take distributions directly out of a 401(k) after 55 but have to wait on IRAs until 59 ½.
A big mistake to avoid: If you are lucky enough to retire at 55, you may not want to roll over that 401(k) to an IRA right away.
Because if you need income prior to 59 ½, you may be able to avoid that tax penalty by taking the income directly from your 401(k). Yes, in almost all cases you can leave it sitting at your company even after retirement. This way, you get the benefit of not paying the extra 10% on your retirement income. Then, after you hit 59 ½, you can roll the balance to your IRA for potentially more investment choices, greater control, and you won’t have to worry about the 10% penalty anymore.
One last thing. Rolling over a 401(k) does not have to be an “all or nothing” event. I have suggested for some to leave enough money in the company plan to cover anticipated pre-59 ½ expenses while rolling the rest. We then took out monthly income from the 401(k) while the IRA balances remained intact.
Don’t get caught moving things that should stay. Be an informed investor!
Join my Email Insider Group. Sign up to receive weekly tips and tricks on finance, education, home buying, insurance, Social Security and everything in between. Click HERE to become an Insider! Byron W. Ellis, CFP®, CLU®, ChFC®, CRPC®, is a CERTIFIED FINANCIAL PLANNER™ professional and Managing Director United Capital Financial Advisers, LLC, a Financial Life Management firm. The information contained in this article is intended for information only is not a recommendation, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances. © Byron Ellis