Keep Tabs On The Old 401
If you decide to leave an account with a former employer, keep up with both the account and the company. People change jobs a lot more than they used to, says Peggy Cabaniss, retired co-founder of HC Financial Advisors in Lafayette, California. So its easy to have this string of accounts out there in never-never land.
Cabaniss recalls one client who left an account behind after a job change. Fifteen years later, the company had gone bankrupt. While the account was protected and the money still intact, getting the required company officials and fund custodians to sign off on moving it was a protracted paperwork nightmare, she says.
When people leave this stuff behind, the biggest problem is that its not consolidated or watched, says Cabaniss.
If you do leave an account with a former employer, keep reading your statements, keep up with the paperwork related to your account, keep an eye on the companys performance and be sure to keep your address current with the 401 plan sponsor.
Keeping on top of how the plan is performing is very important as you may later decide to do something different with your hard-earned money.
What Happens To Your 401 When You Leave A Job
When you leave a job, you have a few options when it comes to your 401. It depends on how much you have in your 401 when you leave and what your planâs policies are as dictated in its summary plan description. Knowing your 401 balance before leaving and having a plan ahead of time can help save you a lot of time and stress.
Roll The 401 Over Into An Ira
What if youre not moving to a new employer immediately or your new employer doesnt offer a 401? What if your employer requires you to put in a number of years before you become vested and eligible to participate in their 401 plan?
In these circumstances, stashing your money in an IRA with the financial institution of your choice is a freeing solution. Youll be able to choose where, how, and when you invest unless you agree to pay a broker to manage the funds for you. A direct rollover is ideal to avoid paying taxes on the amount transferred over you have 60 days to roll your 401 over into the new IRA.
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Avoiding The 10% Penalty:
If for any reason you need to take money out of your 401k sooner than age 59-1/2, there is generally a 10% penalty to be paid on it .
However, as with most of the laws on the books, there are exceptions to these rules. A few of them include:
The employees death
Complete disability for the employee
Separation from service in or after the year the employee reached age 55
Substantially equal periodic payments under section 72
A qualified domestic relations order
Certain deductible medical expenses
A loan
Each one of these exceptions carries their own set of rules and obligations that you must comply with -Resource-Guide—Plan-Sponsors—General-Distribution-Rules” rel=”nofollow”> IRS 401k resource guide). It is highly advised that you speak to a legal or financial representative before using any of them.
In addition, since the 401k vs IRA effort is intended to help you create a secure retirement, it is not recommended that you take money out of your 401k early unless it is truly your last resort. The reason for this is because when you do, that money is no longer in your account generating returns. This disrupts the effects of compound interest which can alter the potential overall balance of your account greatly. Tread with caution if you must exercise this option!
How Long Should You Keep Your 401 Statements
The best thing about saving your 401 statements digitally is you can keep copies of them forever. Not needing to make space for decades of financial records, you can hang onto your 401 statement indefinitely.
Depending on your 401 plan, you should receive quarterly or monthly statements. Additionally, your 401 plan will provide you with annual statements. Your annual statements should be the documents you keep long-term. Save your quarterly statements until you receive your annual statements, then you can discard the quarterly or monthly statements.
As long as you havenât taken any early retirement withdrawals from your 401, you wonât have any tax documents to keep track of.
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Withdrawal Taxes: How To Minimize Them
You wont be able to get out of paying taxes on the funds you withdraw from your 401. However, there are a couple of tips and tricks that might help you lower the total tax you pay. Be sure to check with a tax expert or financial advisor if you want to be sure of the best course of action for your specific situation.
If you happen to hold stock of your company within your 401 account, you could potentially treat the appreciation of that stock as a capital gain rather than ordinary income. The long-term capital gain tax rate is 0%, 15% or 20%, depending on your tax bracket. For many investors, this means a lower tax rate than their ordinary income tax rate. To actually pull this off, youll need to transfer the stock into a taxable brokerage account. Dont be afraid to consult with an expert if you want to take advantage of this strategy.
The other factor to consider is your tax bracket. If your 401 distributions will put you in the lower end of one tax bracket, see if you can start distributions earlier, spreading things out and potentially dropping you into a lower bracket. As long as you start after age 59.5, you could save on your total tax bill with this method.
Early Money: Take Advantage Of The Age 55 Rule
If you retireor lose your jobwhen you are age 55 but not yet 59½, you can avoid the 10% early withdrawal penalty for taking money out of your 401. However, this only applies to the 401 from the employer you just left. Money that is still in an earlier employer’s plan is not eligible for this exceptionnor is money in an individual retirement account .
If your account is between $1,000 and $5,000, your company is required to roll the funds into an IRA if it forces you out of the plan.
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Cash Out Your Old Account
Think long and hard before you do this. Its almost never the best choiceand it triggers a big tax bill!
Advantage
- Its money you can use to pay bills or for another purpose. Also, if you left your job during or after the calendar year in which you turned 55, you wont owe an early-withdrawal penalty.
Disadvantages
- Youll owe income taxes on your money. If you’re in a 30% combined federal and state tax bracket, for example, and cash out a $50,000 account, you’ll have only $35,000 left after taxes.
- You will destroy your retirement nest egg.
The bottom line: For most people, the best option is to move your savings into an IRA, which gives you the most freedom and control over your money.
Why Do Employers Have Vesting Policies
One reason employers have vesting policies is to encourage the longevity of their employees. Many employees will stay in their jobs until they are fully vested in their 401s in order to gain the most financial benefit. For employees, this may be a consideration when it comes time to look for a new job.
On that note, it is always important to consider the financial impact of a new job. If your salary is going to increase significantly, you may be willing to take the hit on your 401 balance, especially if you have only been with the company for a year or two. However, if you are close to the point of being fully vested in your 401, it may be more beneficial to wait a few months or even a year to allow your 401 to become fully vested before switching jobs.
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How Long To Keep 401k Statements
Keeping your 401 statements is a good idea to help keep track of your retirement savings. It also can help keep your retirement funds in your hands.
Given the tax-deferred nature of 401s, itâs possible the contributions you make to a 401 and its balance could be subject to review by the IRS. Although highly unlikely, itâs important to be prepared for such cases. To ensure youâre able to navigate any IRS audits or to simply keep track of your 401âs performance, itâs essential to hold onto copies of your 401 statements. But how long do you need to keep your 401 statements?
How long you keep your 401 statements is up to you. For tax purposes, youâll want to hang onto your 401 statements for at least seven years. However, itâs a good idea to keep your 401 statements for as long as you have money in the account. Once youâve withdrawn all of the funds out of a 401 or have closed the account and rolled over the funds to another retirement account, youâll be fine to discard your old 401 statements.
Thereâs more to saving your 401 statements than just filing away the documents you receive in the mail. Your 401 plan will send you different statements, and knowing the best place to keep them will ensure you donât lose them or donât end up in the wrong hands.
Withdrawing Funds From 401 After 55 But Before 59
If you are 55 or older and still working for the company managing your retirement savings, you cannot take a penalty-free distribution until you are 59 ½. However, you may still qualify to take a hardship withdrawal if you have a qualified expense. You will owe income taxes and a 10% penalty tax on the distribution you take. You may also qualify for a 401 loan if your retirement plan provides this benefit.
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How To Properly Dispose Of Your 401 Statements
Keeping your financial information secure is essential. Not only will it prevent your identity from potentially being stolen, but it will also prevent thieves from gaining access to your 401 and its funds.
If you receive physical copies of your 401 statements and donât wish to keep them, shredding them is the best method for disposing of them. Investing in a shredding machine for your home is an excellent way of getting rid of sensitive documents like your 401 statements. However, remember to scan digital copies of your 401 statements before destroying them.
As far as digital copies, itâs important to remember to delete any copies of your 401 statements before getting rid of any computers or external hard drives.
How Much Should You Have In Your 401k By Age
Now that we have established that you need a 401k in your life and explained how much you can contribute, lets talk cash. Aside from investing enough to meet your employer match, how much should you have in your 401k, really?
One way to answer that question is to look at your age.
While there is no one-size-fits-all answer to the question, How much should I have in my 401k? there are some best practices you can keep in mind to guide your efforts. Yes, while you should start investing in a 401k as soon as possible, some people might not get that opportunity right away and thats okay. The point is to do it when you can.
When you do finally start investing, there are a few good rules of thumb to help you make a sound decision on how much you should have in your 401k.
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But Why Would I Max Out My Roth Ira Before My 401k If Its So Good
Theres a lot of nerdy debate in the personal finance sphere about this very question, but our position is based on taxes and policy.
Assuming your career goes well, youll be in a higher tax bracket when you retire, meaning that youd have to pay more taxes with a 401k. Also, tax rates will likely increase in the future.
The Ladder of Personal Finance is pretty handy when considering what to prioritize when it comes to your investments, but it is just a tool. For more about the Ladder of Personal Finance and how to make it work for you, check out THIS video where I explain it.
PRO TIP: The video is less than three minutes long. It is worth your time.
The Basics Of 401 Withdrawal Taxes
If you are wondering whether your 401 withdrawals are taxed, the short answer is yes your 401 distributions are likely taxable.
This may come as a surprise, because there is some confusion around how retirement accounts work. People often refer to retirement accounts like 401s as tax-advantaged, or tax-deferred. This means investments within your 401 or IRA grow tax-free. Unlike taxable investment accounts, you wont be charged income tax or capital gains tax as your 401 account grows each year.
As an example, if you earn $1,500 before taxes per paycheck, and you contribute $300 of that money to your 401, then you will only be taxed on $1,200. For reference, 401 account holders can contribute up to $19,500 in 2021 , and $26,000 for those 50 and older.
This tax advantage, however, changes once an account holder starts receiving distributions from the 401. As you pull money out, youll owe income taxes on the funds. Some 401 plans will automatically withhold 20% or so of your account to pay for taxes. Youll want to check with your plan provider to see how your particular 401 works.
Wondering when you can start cashing out? Once you reach age 59.5 you can withdraw money from your 401. If you dont need the money yet, you can wait until you reach age 72 to withdraw funds. However, once you reach 72, its no longer a choice to withdraw from your 401, its mandatory. The IRS has defined required minimum distributions for certain retirement accounts, including 401s.
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Eligibility For Cashing Out A 401 Plan
No advice you receive on how to cash out 401 accounts will matter if your plan doesnt allow it. Yes, some employers wont let you take the money out. Even if your employer does, there could be restrictions on how the money can be withdrawn. You probably have some type of documentation with your 401 that you can check. If not, ask your HR department to provide your policy documents. You can always take money out of plans youre not participating in anymore e.g. a plan at an old employer.
If youre 59 and ½ years old, though, none of that matters. You can take money from your 401 starting at age 59 and ½ without paying a penalty. If you havent yet celebrated your 59th birthday, you may prefer instead to take a loan against your 401 if your employer allows it. This will help get you through your financial situation while still ensuring the money is there when its time to retire.
It’s important to note that the tax man may still come calling, even if you dont pay a penalty. Traditional 401 plans are taxed when you take the money out, while Roth 401 accounts hold funds that youve already paid taxes on. If you have a Traditional 401, youll need to prepare to pay taxes on the money, whether you withdraw it at age 24 or 84. If you have a Roth 401, you can take your contributions out at any time since youve already paid taxes on them, but youll pay taxes on any earnings you withdraw early if youre under 59 and ½.
Withdrawing Funds From 401 At 72
If you are age 72, you must start taking annual distributions from the 401, commonly known as required minimum distributions . You must take the first distribution by April 1 of the year you turn 72, and thereafter, you will be required to take the annual withdrawals by December 31 each year. If you delay in taking the first distribution, you must take two distributions in the same year, which will push you to a higher tax bracket. If you miss taking a mandatory distribution, the IRS imposes a 50% penalty on the amount you were required to take during the specific period.
An exemption to the RMDs is if you are still working. To qualify for this exception, you must not own 50% or more of the employerâs company. You can use this exception to delay taking the mandatory distributions until when you stop working.
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No More Creditor Protection
Once youve squared away how long it takes to cash out your 401, its time to think about consequences. The first is the loss of protection against creditors. If youre cashing out because creditors may come knocking, this is something you need to consider. Employer-sponsored 401 plans are often protected against creditors, bankruptcy proceedings, and civil lawsuits. Once youve cashed the funds out, theyll be subject to action along with your other assets.
But before you assume this could be a problem, check to make sure your plan isnt vulnerable for other reasons. If youre in the process of divorcing or are already divorced, the other party could be able to snag a portion of the funds under a qualified domestic relations order. Funds in a 401 can also be seized to pay tax debts and federal penalties.
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