401(k) Distribution Dilemmas

How you will take your 401(k) distributions when you retire can be an important consideration in executing your post-retirement plan.


We all look forward to the day when we can finally kick back, relax and collect our carefully-planned and hard-earned retirement savings. But rushing into withdrawing your retirement funds could cost you a great deal of money in taxes. That’s why planning now for that day is so important.

If your employer’s 401k distribution rules require that your 401(k) plan funds cease when you leave employment, rolling it over to an IRA may be your only option for avoiding unnecessary taxes. A lump sum distribution directly to you will probably bump you into a higher tax rate.

Some employers, however, allow retirees to leave those funds in the company’s 401(k) plan. Given the option – leaving your money in the plan or rolling it into an IRA – which do you choose?

By leaving the money in the 401(k), you can continue to let it grow tax-deferred. You remain subject to the rules of the plan and the investment options offered, and to any changes the employer makes to the plan after you retire. Money in your 401(k) account is protected from creditors in a personal bankruptcy or lawsuit. If you die, your beneficiaries have to take a lump sum distribution.

Despite the ease and attraction of leaving your money in your 401(k) plan, if the plan has limited or poor investment choices, you may want to opt for the 401k rollover.

Rolling your 401k savings into an IRA allows you to continue investing and growing your assets tax deferred. It also gives you more control over when and how to invest your money and, to some extent, when you take distributions. If you have multiple qualified plans (for example, accounts at several different employers), consolidating them into an IRA can not only make them easier to manage, but may help you qualify for break points or sales charge discounts in mutual funds. If you die, distribution of IRA funds to your beneficiaries may be spread over several years. However, funds in your IRA do not have protection from creditors.

You should note that 401k rollovers to an IRA from other qualified plan accounts are best made directly to avoid incurring any penalties or additional taxes. You will be subject to a 20% automatic withholding for income tax plus a 10% penalty, if you are under age 59½. Withdrawn funds must be in the new account within 60 days, or the amount you received will be taxable.

You are not required to take an income distribution from a qualified plan – 401(k) or IRA – until age 70½. The benefits of tax-deferred compounding usually make it advantageous to access these accounts after using funds from other accounts. Required minimum distributions – the amount the government makes you take out of qualified plans after age 70½ – cannot be used as contributions to another qualified plan.

No matter which method you choose for taking distributions from your 401(k) during retirement, the key is stick to your investment plan and make sure that you’re choosing the most appropriate method of withdrawal. Your financial professional can be an important resource for helping you make those decisions.