September 10, 2013
By Gary Foreman
According to most estimates, between 8,000 and 10,000 baby boomers will reach retirement age each day. And with there being 51 million 401k accounts in existence, you can bet that many of the new retirees will be wondering how to access the money they've saved during their working years. So let's examine 401k withdrawals in retirement.
There are two sets of rules that you'll need to heed when you withdraw money from your 401k. The first set is from the plan itself. To find out what those rules are you'll need to contact your plan administrator. You'll find their contact information on your account statement.
Most of those rules won't be a problem. They may limit how often you withdraw or set minimum amounts you can take out. It's also possible that some things that are allowed by law won't be available in your plan.
The second set of rules comes from the IRS code. And, as you might expect, they tend to be more complicated.
The first thing to know about your 401k is that you can withdraw money at any age. But, if you aren't 59 1/2 or older you'll pay an early withdrawal penalty of 10% unless you qualify for the lump sum distribution that's available beginning at age 55.
You can't leave the money in the 401k forever. Federal law requires you to begin taking distributions the year that you turn 70 1/2. The exact amount will be based on your life expectancy. For instance, if you're expected to live 15 more years, you'll be required to take about 1/15th of the value of the account this year.
Any amount withdrawn will be added to your taxable income for that year. So, if you can, you want to take smaller amounts for many years. That will keep you in lower tax brackets.
Tax laws allow for five basic options for your 401k when you retire. You may choose to:
1. Take a lump sum distribution
2. Leave your money in the 401k
3. Roll the money into a self-directed IRA
4. Begin to take regular distributions
5. Use the money to buy an annuity
Lump sum distribution. Choosing to take out all of your money is the quickest way to get at your money, but triggers two disadvantages. First, because all of that money will be added to your taxable income it could push you into tax brackets meant for the wealthy. Second, the law requires that the IRS withhold 20% that will be applied to your next year's tax bill.
Leave the money. Unless your plan forbids it, you could just leave the money in the account. The biggest advantage to this is that your money will continue to grow on a pre-tax basis. That can be a huge advantage over 20 or more years. The disadvantage is that you'll be limited to the investment options offered within your plan. You also may be subject to higher fees to manage your money and will ultimately be required to take withdrawals when you turn 70 1/2.
Roll into an IRA. Moving the money directly into an IRA has no tax consequences. And, once there, you'll have more choices as to how you invest your money. Some IRA's even allow you to invest in gold, silver or physical assets. And, like the 401k, your money will grow on a pre-tax basis. One disadvantage is that you'll probably need to liquidate the assets you hold in your 401k and transfer them into the IRA as cash.
Make regular withdrawals. Typically monthly or quarterly. You can adjust the amounts annually and you are not subject to withholding so you get to use all of your money until tax day. The advantage is a steady predictable income. The only disadvantage is that the value of your account gradually shrinks.
Buy an annuity. You can use part or all of the money in your 401k to buy an annuity. Various types of annuities are available. Generally they'll pay you a preset amount each month/year for the rest of your life. The predictable income is nice, but remember that even 3% inflation will double prices every 25 years. So your checks will buy a little less each year.
Consider your options carefully. How you handle your 401k account when you retire is a major decision. It will affect your income for the rest of your life.
It can also affect other financial affairs. For instance, creditors can't access your 401k account, but in some cases they could access an IRA. Your financial advisor can advise how your unique situation applies to the law and your 401k plan.
Currently there's over $3.5 billion in 401k accounts. Sooner or later we'll all be deciding how to access the money that we've saved!
Gary Foreman is a former financial planner who founded The Dollar Stretcher.com website and newsletters. The site features thousands of articles on how to save your valuable time and money including an article on 401k retirement distributions.
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