Retirement Planning: Understanding Your Withdrawal Alternatives

More than 20 million Americans currently participate in 401(k) plans through their employers with an average account balance around $30,000. These pension plans can help to provide security for a comfortable retirement. It’s important to understand, however, the tax implications of these pension plans when you decide to change employers or perhaps are a victim of corporate downsizing. If you’re a plan participant, there are several alternatives available to you:

• You may leave all or some of your retirement savings with your previous employer’s plan (although some plans may require you to automatically rollover if your plan proceeds are $5,000 or less). These investments are often professionally managed at a lower cost than if you roll your account into an IRA. Unlike an IRA, distributions are not required in an employer-sponsored plan if you’re still working at age 70-1/2 (subject to plan documents and other limitations). In addition, assets in 401(k) plans are protected in the event of bankruptcy.
• Second option for your retirement plan savings is to transfer the money to a new plan. Internal Revenue Service rules allow a transfer of the funds from a 401(k) plan or other employer-sponsored plans to retirement plans of your new employer. This can be done even though you may not be eligible for the new plan for several months. When making these transfers between employers, the investments are first converted to cash and then the reinvestment is made.
• Third option is to withdraw all or a portion of your retirement savings as a lump sum. Any remaining balance in your plan will continue to grow tax-deferred. Be advised that you must pay Federal, State, and local income taxes on the entire amount you receive. Also, if you are under 59-1/2 years old, a 10 percent IRS penalty for early withdrawal may apply. In addition, the IRS requires a 20 percent automatic withholding if you’re not rolling it over to another retirement plan or an IRA. By making a total lump-sum withdrawal, you do control all of your assets. However, you are now solely responsible for managing your money efficiently in order to meet your income needs.

Lastly, your retirement savings can be rollover to an IRA. In this case, your savings continues to accumulate tax-deferred until you begin making withdrawals. If you choose this option, you might want to consider having the money rolled over directly to your new IRA account. Here’s why: if you receive your lump-sum amount check first and then deposit it, 20 percent is withheld because the IRS is assuming you’re planning to cash out your entire savings. So one of the most important things you may want to remember if you decide to leave your current employer is to investigate your options before making any final, irrevocable decision. You may save more in the long run.