I'm about to retire and I'm wondering whether to move my 401K plan to an IRA. Should I or shouldn't I?Another thought provoking article by Ernie McDaniel - as seen in Forum News. |
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This decision is mostly about avoiding taxes as long as possible and as much as possible for both yourself and your heirs. This isn't a minor issue. The right decision may mean several times more wealth ultimately distributed to yourself, your spouse and your children.
If you leave your money with a 401(k) plan, there is the great likelihood that, upon your death, the plan requires rapid disbursement of the contents. This may result in taxation of the proceeds over a period as short as five years, and even worse, loss of tax-deferral opportunity for a generation or two. Clearly, this is plenty reason to move to your funds to an IRA.
On the other hand, if you are between the ages of 55 and 59-1/2 and wish to take income from your funds now, as certainly you might if you are retiring from work altogether rather than from one job to another, then for the period until you become age 59 1/2 you might want to leave your funds with the 401(k). Why? Because during this time you are allowed by law to withdraw funds from the 401(k) without penalty -- you pay income tax only. Contrarily, funds drawn from an IRA in this age range would normally be penalized 10% in addition to the income tax.
There are in fact ways to withdraw funds from an IRA during this period without penalty. Special needs, such as a proven disability, may make the funds available. More commonly utilized is the 72(t) provision, which allows an IRA-holder to take systematic payments from his account without penalty. This arrangement requires, however, that an amount prescribed by law be drawn on a regular schedule without variation for a period of at least five years or to age 59 1/2, whichever is longer. 72(t) can cause more money to be drawn than is needed for income, and also cause this income to be drawn for a longer period than needed - both substantial disadvantages. If you are between ages 55 and 59 1/2, you may therefore prefer to leave your funds with the 401(k) plan.
The typical 401(k) plan does have the disadvantage of providing only a limited number of investment options as compared to the myriad and varied IRA investment choices available with mutual funds, deferred annuities, banks and brokerage houses. The usual 401(k) plan also provides little, if any, investment guidance, while guidance may be more available for IRA plans through the many providers. All the pros and cons of each choice must be considered as you weigh them and your personal needs.
As an important aside, let me warn you against the common mistake of choosing neither the 401(k) nor the IRA options you have presented. Too many folks pull their retirement plan money out en masse when it becomes available and must then pay huge amounts of income taxes, as well as the possible 10% penalty. Even worse, as hard as anything worse is to imagine, these investors lose the benefit of tax-deferred growth on the bulk of their principal for years to come. No matter what, please do avoid this disastrous tax mistake.
The tax-deferral opportunity with 401(k) and IRA plans is the best tax reduction tool available to ordinary investors but is horribly underappreciated and therefore too often treated cavalierly. For many folks, these funds make up their single largest category of retirement assets, so a mistake may cause years of lost or lower retirement income. Bottom line: Any decision regarding movement of 401(k) or other employer plan money, also any decision regarding moving IRA money, should be given due consideration and made only after personal consultation with a trusted financial professional.
For your free copy of my easy-to-understand 401(k) Decision-Making Guide, call 318-798-9022 or email ernie@mcdanielfinancial.net or write 2001 E. 70-th, Suite 407, Shreveport, Louisiana 71105.
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