What You Need To Know To Avoid Costly Mistakes
In an ideal world, everybody would leave their 401 funds alone until they need the money for retirement. That might mean rolling your account over to an Individual Retirement Account , but it also means not cashing out the funds prior to reaching retirement age, to allow the money to grow to its maximum potential amount. In investing, time truly is your best asset. At some point though, you will begin taking distributions, and here’s what you need to know.
The best way to take money out of your 401 plan depends on three things:
Questions To Ask If You’re Considering A 401 Loan
If youre thinking of borrowing from your 401, plan ahead by asking your 401 service provider about the borrowing process, such as:
- Are loans allowed? Ask about the types, terms, and costs.
- How much can I borrow? This varies with your plan balance.
- What are the steps? Processes differ, and there may be paperwork if you want a home loan.
Keep in mind that loan checks are usually mailed, so they may take time to reach you.
Anything Else I Should Know
Yep. A few things, actually.
Once you contribute to a 401, you should consider that money locked up for retirement. In general, distributions prior to age 59½ will be hit with a 10% penalty and income taxes.
If you leave a job, you can roll your 401 into a new 401 or an IRA at an online brokerage or robo-advisor. The IRA can give you more control over your account and allow you to access a larger investment selection.
401s typically force you to begin taking distributions called required minimum distributions, or RMDs at age 72 or when you retire, whichever is later. You may be able to roll a Roth 401 into a Roth IRA to avoid RMDs.
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What Happens To Your 401 When You Leave Your Job
You basically have four options when you leave your job: Do nothing and leave the money in your old 401, roll it over into an IRA, roll it into your new employers 401 plan, or cash out your 401.
Lets get this out of the way: Do not cash out your 401plan. Bad idea! Heres why: When you cash out your 401, you dont even get to keep all of the money! Youll owe taxes on the total amount as well as a 10% withdrawal penalty.
Lets say youre in the 24% tax bracket and decide to cash out the $10,000 you have in your 401 plan when you leave your job. Even though you started with $10,000 in your 401, youll be left with only $6,600 after taxes and penalties.
Your best option is to roll over your 401 funds into an IRA because it gives you the most control over your investments and what mutual funds to choose from.
If you rolled that $10,000 over to an IRA and let it grow for 30 years, it could be worth about $267,000! Even a small cash-out has a big impact on your savings. Your financial advisor can help you roll over any old 401s so you get the most out of your investment.
Contributing To Both A Traditional And Roth 401
If their employer offers both types of 401 plans, employees can split their contributions, putting some money into a traditional 401 and some into a Roth 401.
However, their total contribution to the two types of accounts can’t exceed the limit for one account .
Employer contributions can only go into a traditional 401 account where they will be subject to tax upon withdrawal, not into a Roth.
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Retirement Funds Are Different
They are not turned over to the state, which means, its possible that nothing will happen to your money until something happens with your company ).
A common scenario is when you leave a company and move, perhaps you even change your email address.
Perhaps months or even years have gone by, or youve moved to the other side of the country. Then something happens with your employer and they need to contact you for instructions of what to do with your account.
Option : Move The Money To Your New 401
If you have a new job with a new 401, your current employer may permit you to roll over your old 401 funds into your new account. However, not all plans allow this, so check with your company’s HR department or plan administrator to see if it’s an option for you.
If it is and you decide it’s your best move, you must choose between a direct and an indirect rollover. Direct rollovers are the better choice because you don’t handle the money at all. You just fill out a form telling your old plan administrator where to send the funds and they take care of it for you.
With an indirect rollover, the plan administrator cuts you a check for the funds in your account and you place that money into your new account. But if you fail to do this within 60 days of cashing out your old account, the government considers it a distribution and taxes you on that money for the year.
Before you decide to move your money to your new 401, make sure you like your investment options and are comfortable with the fees your new 401 charges. Many employers don’t allow you to transfer money out of your 401 if you’re a current employee, so once you transfer your old 401 funds to your new account, they could be stuck there, at least until you leave your current job.
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Eventually You Must Withdraw Money From A 401
Uncle Sam won’t let you keep money in the 401 tax shelter forever. As with IRAs, 401s have required minimum distributions. You must take your first RMD by April 1 in the year after you turn 72. You will have to calculate an RMD for each old 401 you own. Once you’ve determined the RMD, the money must then be withdrawn separately from each 401. Note that unlike Roth IRAs, Roth 401s do have mandatory distributions starting at age 72.
If you hit that magic age, you are still working, and you don’t own 5% or more of the company, you don’t have to take an RMD from your current employer’s 401. And if you want to hold off on RMDs from old 401s and IRAs, you could consider rolling all those assets into your current employer’s 401 plan.
How Much Does The Average 65 Year Old Have In Retirement Savings
According to data from the Federal Reserve, the average amount of retirement savings for 65- to 74-year-olds is just north of $ 426,000. Although it is an interesting data point, your specific retirement savings may differ from that of someone else.
How much savings should I have at 65?
At the age of 65, you should have a savings / net amount equivalent to 20X -25X your annual expenses. In other words, if you spend $ 50,000 a year, you should have about $ 1,000,000 $ 1,250,000 in savings or net worth to live a comfortable retirement lifestyle.
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The Downside To 401 Loans
The biggest drawback to a 401 loan is that the money you borrow doesnt earn an investment return, and this can cost you.
If you take a five-year loan at an interest rate of 5.75% , your loan balance will be more than 30% less than if youd left that amount invested and growing at 5%.1 There are other drawbacks:
- If you dont repay your loan, it goes into default. A defaulted loan becomes a withdrawal and may be subject to taxes and penalties. It also permanently drains your retirement plan.
- Loan fees are paid to the service provider. Fees vary, but they’re usually in the range of $50 to $75 and can be ongoing.
- You normally have to pay back your loan immediately if you leave your job. If youre considering a job change, youll need to make plans to repay your loan so that you dont default on it.
- 401 loan interest is double taxed. You pay loan interest into your 401 with after-tax dollars, and youre taxed on those same dollars again in retirement.
Loans can be habit forming.Statistically, people whove borrowed before are more likely to borrow in the future than people who havent borrowed at all.
Make Sure You Actually Contributed
Before you go through the hassle and process of calling the HR department at your old employer, or searching through databases, its a good idea to verify that you contributed to the plan.
If you are unsure if you contributed to a 401 plan, you can check your previous year tax return and old W-2. Any contribution will be in Box 12 of the W-2.
ERISA, or the Employee Retirement Income Security Act of 1974, sets minimum standards for retirement plans, and protects retirement savings from abuse or mismanagement.
Among other things, employees are required to make annual reports
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How Do You Know Its Time To Retire
Contents
5 signs that it is time to retire
- You dont want to work anymore and can get paid to do that. Job change does not interest you.
- You are ready to move on to the next chapter in your life.
- Your work is no longer part of your identity.
- Work is no longer in your mind, adventure is.
- Your mental and physical health requires rest.
How do you know if you are emotionally ready to retire? Some of the main emotional signs you may be willing to retire include: Becoming indignant about your job, or revisiting retirement during work hours to such an extent that it distracts you from finishing your job. Be jealous of your retired friends and count the days until your own retirement.
What Is A Good 401k Balance At Age 60
The goal is for you to live a good retirement life and not have to worry about money. The higher average 60-year-old should have at least $ 800,000 in their 401k if they diligently save and invest. However, the average 60-year-old has closer to $ 170,000 in his 401k.
How much does the average 60 year old have in retirement savings?
If you are approaching the age of 60, you probably have a retirement in your mind. Have you saved enough? Exactly what is the average 60-year-old in pension savings? According to data from the Federal Reserve, for 55- to 64-year-olds, that number is just over $ 408,000.
What is the average net worth of a 60 year old?
According to Fed data, the median net worth for Americans in their late 60s and early 70s is $ 266,400. The average net worth for this age group is $ 1,217,700, but because averages tend to lean higher due to high-value households, the median is a much more representative amount.
How much retirement should I have at 60?
Age 50 five times annual salary. Age 55 a six-year salary. Age 60 seven times annual salary. Age 65 eight times the annual salary.
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Track Down Previous Employer Via The Department Of Labor
If you cant find an old statement, you may still be able to track down contact information for the plan administrator via the plans tax return. Many plans are required to file an annual tax return, Form 5500, with the Internal Revenue Service and the Department of Labor . You can search for these 5500s by the name of your former employer at www.efast.dol.gov. If you can find a Form 5500 for an old plan, it should have contact information on it.
Once you locate contact information for the plan administrator, call them to check on your account. Again, youll need to have your personal information available.
Leave It With Your Former Employer
If you have more than $5,000 invested in your 401, most plans allow you to leave it where it is after you separate from your employer. If it is under $1,000, the company can force out the money by issuing you a check, says Bonnie Yam, CFA, CFP, CLU, ChFC, RICP, EA, CVA, CEPA, Pension Maxima Investment Advisory Inc., White Plains, New York. If it is between $1,000 and $5,000, the company must help you set up an IRA to host the money if they are forcing you out.
If you have a substantial amount saved and like your plan portfolio, leaving your 401 with a previous employer may be a good idea. If you are likely to forget about the account or are not particularly impressed with the plans investment options or fees, consider some of your other options.
When you leave your job and you have a 401 plan which is administered by your employer, you have the default option of doing nothing and continuing to manage the money as you had been doing previously, says Steven Jon Kaplan, CEO, True Contrarian Investments LLC, Kearny, New Jersey. However, this is usually not a good idea, because these plans have very limited choices as compared with the IRA offerings available with most brokers.
Specifying a direct rollover is important. That means the money goes straight from financial institution to financial institution and doesn’t count as a taxable event.
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How Many Types Of 401s Are There
There are two basic types of 401straditional and Roth. Both are employer-sponsored retirement savings plans, but theyre taxed in different ways.
A traditional 401 offers tax benefits on the front end. Your money goes in tax-free, but you pay taxes on the employer match and the withdrawals you take out in retirementthat includes all the growth on your contributions as well.
A Roth 401 offers tax-free growth. What does that mean? Your contributions are taxed up front with after-tax dollars, but then you dont pay taxes on your contributions or their growth when you retire. You will still owe taxes on employer contributions.
There are also a few other types of 401s available for folks who are self-employed or own small businesses:
- Solo 401: Also known as a one-participant 401, the solo 401 was created for business owners who work for themselves and dont have any employees. It allows you to make contributions as both an employee and as an employer.
- SIMPLE 401:If youre a small business owner with no more than 100 employees, then the SIMPLE 401 is for you . As an employer with this plan, you must offer a matching contribution of up to 3% of each employees pay or put in 2% of each employees pay .1
Contact The 401 Plan Administrator
If your employer is no longer around, try getting in touch with the plan administrator, which may be listed on an old statement.
If youre unable to find an old statement, you still may be able to find the administrator by searching for the retirement plans tax return, known as Form 5500.
You can find a 5500s by the searching the name of your former employer at www.efast.dol.gov.
If you locate a Form 5500 for an old plan, it should have the contact information on it.
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Youve Got Options But Some May Be Better Than Others
After you leave your job, there are several options for your 401. You may be able to leave your account where it is. Alternatively, you may roll over the money from the old 401 into a new account with your new employer, or roll it into an individual retirement account , but you must first see when you are eligible to participate in the new plan. You can also take some or all of the money out, but there are serious tax consequences to that.
Make sure to understand the particulars of the options available to you before deciding which route to take.
Roll It Over To Your New Employer
If youve switched jobs, see if your new employer offers a 401 and when you are eligible to participate. Many employers require new employees to put in a certain number of days of service before they can enroll in a retirement savings plan.
Once you are enrolled in a plan with your new employer, its simple to roll over your old 401. You can elect to have the administrator of the old plan deposit the contents of your account directly into the new plan by simply filling out some paperwork. This is called a direct transfer, made from custodian to custodian, and it saves you any risk of owing taxes or missing a deadline.
Alternatively, you can elect to have the balance of your old account distributed to you in the form of a check. However, you must deposit the funds into your new 401 within 60 days to avoid paying income tax on the entire balance. Make sure your new 401 account is active and ready to receive contributions before you liquidate your old account.
Consolidating old 401 accounts into a current employers 401 program makes sense if your current employers 401 is well structured and cost-effective, and it gives you one less thing to keep track of, says Stephen J. Taddie, managing partner, Stellar Capital Management LLC, Phoenix, Arizona. Keeping things simple for you now also makes things simple for your heirs should they need to step in to take care of your affairs later.
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