As more and more companies are offering 401(k) plans to their employees for retirement savings rather than traditional defined benefit plans, more of us are left with a big choice when we leave our place of employment: What do we do with our retirement savings, which may be a sizeable nest egg by this time?
401(k) plans are tax advantaged: money that is invested in these retirement accounts is "pre-tax," meaning that you pay no income tax on your annual contributions.
Further, your 401(k) can grow tax-free; no taxes are due on any interest, dividend, or capital gains earnings during the course of any given tax year.
Taxes only fall due when you begin making withdrawals from your 401(k), and these withdrawals are then taxed as ordinary income.
Usually, the worst thing you can do with a 401(k) account when you leave your place of employment is to withdraw the entire sum. Not only will you owe a sizeable tax bill on this withdrawal, but, if you withdraw the funds prior to age 59½, you will owe a 10 percent penalty as well.
Fortunately, you have other options. If you are simply moving from one employer to another, you can take your 401(k) account with you; contact the human resources departments of both your old employer and your new employer to help arrange the transfer. One advantage of this strategy is that it’s easily done; another is that your retirement savings plan will continue without missing a beat. Often, employees will delay opening 401(k) accounts with their employers, and they will miss many precious months, or years, of retirement savings growth. If you simply transfer your old 401(k) to your new employer and set up automatic contributions, the work is already done.
One possible disadvantage to this strategy, however, is that you are "stuck" with whatever investments your new employer offers with regard to 401(k) plans. Be sure that you closely examine your new employer’s plan, to ensure that there are sufficient investment options that are suitable to your goals. Also, some 401(k) plans extract high fees; be sure you know what these fees are before committing.
If you choose not to participate in a new employer’s 401(k), or if your new employer does not offer a 401(k) or other defined contribution plan, or if you are retiring for good, then you have other options. Your 401(k) can be rolled over, in whole or in part, into an Individual Retirement Account (IRA) at almost any financial institution that offers investment services and products. As with a 401(k), your money will grow tax-free in an IRA, and taxes will not be due until you begin making withdrawals.
If you roll your 401(k) over into an IRA brokerage account, you will then have almost limitless options on how you wish to invest your retirement nest egg: individual stocks, Exchange Traded Funds (ETFs), mutual funds, individual bonds and bond funds, and more exotic investment products. A brokerage account will offer you the ultimate in flexibility, but be sure you have an investment strategy, or seek help in formulating one. Too much choice can sometimes be a bad thing, and every trade that you make in a brokerage account will cost you a transaction fee. And, if you are retired already but don’t yet need to make withdrawals from your IRA, stick mostly with conservative investments.
If a brokerage account is too open-ended for your style, you can roll your 401(k) into a regular IRA account at any of scores of reputable investment houses such as T. Rowe Price, Vanguard, and Fidelity; here, you will have the option of investing your retirement savings in any of the mutual funds offered by that investment house. Although your choices will be more limited than at a brokerage account, most big investment houses offer a broad enough range of mutual funds to suit just about any style.
When rolling over your 401(k), you always have the option of taking some of your money out in cash, but remember that you will pay ordinary taxes on any withdrawal, plus a 10 percent penalty on the amount withdrawn if you are younger than 59½. The remainder of your next egg, whether in a new 401(k) with a new employer or in an IRA, will continue to grow tax-free until you choose to begin making withdrawals. In most cases, you MUST begin withdrawing from any tax-advantaged retirement account after you turn 70½.
IRA Calculator will help you determine:
IRA calculator helps you decide whether a Traditional or Roth IRA is best suited for your needs.
How much you need to withdraw each month once you retire to live comfortably
How much you need to contribute each month to maximize employer contribution for monthly retirement withdrawal goal
How you can forecast for your contributions’ affect on your retirement savings can be done through our online 401-K calculator.