Option : Do A Rollover To An Ira And Take Control Of It
An IRA is an account you can set up on your own as opposed to a 401 which is sponsored by your employer. As noted above, you can rollover your 401 to an IRA once you leave your employer. If you decide to pursue this route, you can opt to rollover your funds to either a traditional IRA or Roth IRA.
If your contributions to your 401 were pre-tax, rolling over to a traditional IRA may be the simpler and preferred option because it will have no tax consequences. Your assets will continue to grow tax-deferred and be taxed on the distributions when you retire. See tax details further down in the article. Traditional 401s and IRAs also have Required Minimum Distributions when you reach 70 ½.
Another option is to rollover to a Roth IRA. If you opted for a Roth 401, again this will have no tax consequence except for any employer match amount, which is always pre-tax. But if you opted for a pre-tax 401, rolling into a Roth IRA will cause a large tax consequence – youll owe immediate tax on the contributions and growth. The main advantage of a Roth IRA is that you wont have to pay taxes on qualified distributions when you retire because the funds have already been taxed and grow tax-free. Sometimes it makes sense to rollover to a Roth IRA in a year when you have a low income because the potential gain in tax-free growth on the assets may be greater than the one-time tax hit.
What Is A 401 Plan
Lets start with the basics. A 401 is an employer-sponsored plan for retirement savings. It allows employees the benefit of having retirement savings taken out of their paychecks before taxes. If your workplace offers a 401, youll fill out an enrollment packet that includes information about vesting, beneficiaries and investing options.
Why is it called a 401? The 401 plan is named for the 401 subsection of the tax code that governs how it works. Thats really all there is to it. The same goes for other plan types like the 403. Easy enough, right?
Dont Count On Social Security To Fund Your Retirement
Personally, I would take social security income completely out of the equation. If you get money from social security that is just icing on the cake. I dont want to plan on living on social security.
Social security was never intended to fund anyones retirement. It was started as a supplemental program and unfortunately, many people are unaware of how small the payment actually are.
On a side note, you have to read this article about how social security income is taxed. I bet you didnt realize that if you earn too much money in retirement, then the government will take some of it back in the form of a benefit tax.
Individuals with a combined income over $34,000 and couples with a combined income over $44,000 could be taxed on up to 85% of their benefits.
Crazy huh! I didnt realize that the government taxed social security income. Seems pretty unfair since youve already been taxed on the money.
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Is A 401k Worth It
As youve now learned, 401s are one of the worst tools for wealth-building.
At best, a 401k will provide you with a moderate retirement nest egg when you finally reach 59.5 years old. As the term nest egg suggests, this approach is fragile.
Wall Streets obsession with pushing the 401 onto hundreds of millions of Americans reminds me of how marketing campaigns in the 1970s and 1980s pushed that cheap, sugar-packed, carb-dense cereals were a healthy breakfast food.
Thousands of health studies have now confirmed that sugary cereals are not only a poor breakfast choice, but are detrimental to your long-term health and a key factor that has contributed to the alarming rise in childhood obesity.
Similarly, there are now 55 million workers contributing to 401k plans, which hold more than $5 trillion in assets. That is $5,000,000,000,000 with TWELVE zeros.
If our 401 system was working for these hard-working people, then why are the vast majority of Americans still scraping to get by?
If we have this great retirement tool called the 401 plan, then why do 40% of Americans not have $400 in the bank for emergency expenses? Should it concern us that 60% of Americans would be unable to pay for an unexpected expense of $1,000?
These are the hard questions that we should be asking.
I Can Invest Just As Well Or Even Better Than These Money Managers That I Am Paying Large Yearly Fees
This is going to be the kicker for many people. If you do not feel that you can invest as well as money managers or if you do not feel like you want to pursue this path, then by all means a set it and leave it 401k approach is for you. Or even if you want to drop the high fees, you can find low cost mutual funds or an Exchange Traded Fund which will track the markets for you.
But if you are like me and you enjoy the management of your money and are willing to take complete 100% responsibility for your financial future, then I believe you are ready to do without a 401k money manager and those high fees that come along with it.
Dont get me wrong. Self-investment is not the path for everyone. And there is no shame in the passive or no management approach of the 401k. In fact, I have done this approach for nearly 10 years while I have studied and prepared myself for the transition to be my own investor.
Only now do I feel ready enough to say good-bye to my 401k and hello to self-investing in stocks of my own choosing. It is exciting and scary all at once as one wrong investment could spell doom for my portfolio. However, I am at a point where I am willing to be the active investor. And willing to take that bet on my own investment prowess.
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What Does It Mean To Be Vested
Vested is a term used to talk about how much of your 401 belongs to you if you leave your job. The money you contribute is yours, but some employers have guidelines about how much of their matching contribution you can take with you.
For example: If your company increases the amount you are vested in by 25% every year, leaving your job after only two years would mean you could only take 50% of the employer contributions to your 401 with you. Once youre fully vested, you keep 100% of the employer contribution. Your HR department can provide specific information about your companys vesting guidelines.
I Will Be Forced To Take Distributions At A Certain Age
In my 401k, when I hit 70 ½, I will be forced to take out distributions from my overall portfolio. That means that whether I need the money or not, I will be forced to sell certain assets to pay for my lifestyle.
Not only will this distribution incur a distribution fee of $50, but I will also be selling off my asset base, which as an investor I hate to see. More on this below.
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Scenario : Monthly Pension
If you receive distributions as a monthly pension, you should check about the status of a tax treaty between the US and your home country. In most cases, you will only have to pay taxes in the country where you are a resident. If you have moved back to India, for instance, you only have to pay taxes in India when you receive your monthly 401 pension. However, you may still be required to file US tax returns. If there is no treaty between the US and your home country, the brokerage has to withhold 30% from the monthly distributions.
Since taxation rules and requirements differ from one country to another, it would be best to consult a tax advisor like MYRA prior to your move to help you create a strategy.
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What Is A 401k And How Does It Work
One common vehicle for building up retirement savings is a 401k. A 401k is a tax-deferred savings plan offered through employers. A tax-deferred contribution reduces the amount you are taxed on in each paycheck, so the tax savings will partially offset the amount you deduct. If you contribute, say, $100 from each paycheck, your paycheck will be less than $100 lower than if you didnt contribute .
Basically, you dont pay taxes on money you invest in a 401k, or the interest it earns, until you withdraw it. By then, you will likely be in a lower tax bracket due to retirement.
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Can You Lose Your 401k If The Market Crashes
Its normal for you to see your 401 lose value at certain times. Your mutual funds may not perform as well, the stock market dives or your 401 may need reallocating. Youll still have years for the economy and your 401 to recover. For example, when the stock market crashed in 2008, the S& P 500 dropped 38.49%.
What Are The Rules For 401 Withdrawals And 401 Loans
When life happens, its easy to turn to the savings stashed in your 401. The money is just sitting there, right? Turns out, withdrawing money from your 401 early is more complicated than that.
According to the IRS, you cant withdraw money out of your 401 before you reach the age of 59 1/2 without paying income taxes and a 10% early withdrawal penalty.5
But there is a loophole: 401 loans allow you to use your retirement savings without paying penalties or taxes as long as you pay the money back. Of course, doing this comes with a bunch of rules and things can go wrong really fast.
Heres why 401 loans are a really bad idea:
- You have to pay back the amount you withdraw with interest.
- Your investments into your workplace 401 account are pre-tax, but youll pay back the loan with after-tax dollars. That means it will take longer to build up the same amount.
- Youll have to pay additional taxes and penalties if you dont pay back the loan in a certain time frame.
- If you leave your job for whatever reason and still have an outstanding 401 loan balance, you have to pay it back in full by the tax filing deadline of the following year, including extensions .6 Under previous law, you had 60 to 90 days to pay off your balance completely.
Thats a lot of good reasons to keep your hands off your 401 until you reach retirement age.
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Your 401 Comes With High Fees
All that potential for growth isnt usually free, and a fee may be charged for managing your 401 plan. Your employer is required to provide you with a fee disclosure statement each year, but its easy to dismiss if its just a small percentage. However, that seemingly low fee can add up to a big loss for you over time, especially if youre maxing out your 401 each year. This fee calculator from AHC Advisors can show how even a small percent of your investment can really add up over time. If the fee is too high, you may be better off exploring other investment options.
Disclosing Plan Information To Participants
Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plans structure and operations, and provide them a chance to make decisions and take timely action with respect to their accounts.
The summary plan description – the basic descriptive document – is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the plan features and what to expect of the plan. Among other things, the SPD must include information about:
- When and how employees become eligible to participate in the 401 plan
- The contributions to the plan
- How long it takes to become vested
- When employees are eligible to receive their benefits
- How to file a claim for those benefits and
- Basic rights and responsibilities participants have under the Federal retirement law, the Employee Retirement Income Security Act .
The SPD should include an explanation about the administrative expenses that will be paid by the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.
A summary annual report is a narrative of the plans annual return/report, the Form 5500, filed with the Federal government . It must be furnished annually to participants.
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What Is A 401k Plan
A 401 plan is a retirement savings vehicle offered by an employer to an employee. It lets the employee save a fraction of their paycheck and invest it without taxes being taken out first.
Instead, taxes are deferred until the money is withdrawn from the account when the employee reaches 59.5 years or older.
Originally, the 401 plan was set up so employees and employers could exclude a small amount of their salary from being taxable. They were also structured to allow employers to contribute small amounts, matching either some or all of the employees contributions.
Despite these small benefits, its critical to remember that any distributions including your earnings are taxable income when you retire.
Many of us grew up being told by our parents and peers that we had to invest in a 401 retirement plan. We were taught that 401 plans were the mainstay of our generous employers who would match our dollars to help us create a retirement nest egg.
Does a 401 make sense in todays marketplace? The answer to that is a resoundingNO.
Max Out 401 Contributions Or Pursue Other Investment Options
OK, so you have all your financial ducks in order and are able to set aside the full contribution. Is it time to max out 401 contributions? There are other options to consider. Deciding where to invest money beyond the amount required to meet your companys match limit primarily comes down to one thing: fees.
If the fees in your employer-sponsored plan are high, direct additional money to a traditional or Roth IRA. The contribution limit is much lower $6,000 in 2021 so if you have spare money beyond that, funnel it back into the 401.
When choosing between the traditional and Roth variety of an IRA or 401, the difference comes down to when youll be taxed. In traditional accounts, contributions are pretax and distributions in retirement are taxed with Roth accounts, contributions are made after taxes but retirement distributions are tax-free.
Another perk of both types of IRAs? These accounts typically have a broader assortment of investments, such as exchange-traded funds. If youre in a place financially where you can max out a 401 and IRA without jeopardizing other goals, do it, Irace advises.
If you’re looking for either a traditional or Roth IRA, explore our top-rated brokerages below, or check out our roundup comparing even more brokerage options.
More retirement resources
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What To Invest In
The higher the risk, the greater the return. Riskier investments, like stocks, pay more than safer investments, like bonds. You want to have a mix of both, with more risky investments when you are younger, and safer investments as you age.
Financial planners often recommend investors under 40 put about 75-90% in stocks and the rest in bonds. In your 40s and 50s start shifting the balance so that when you reach your 60s youll have about 60% in bonds and 40% in stocks.
Leave Your Retirement Savings In Your Former Qrp If The Qrp Allows
While this approach requires nothing of you in the short term, managing multiple retirement accounts can be cumbersome and confusing in the long run. And, you will continue to be subject to the QRPs rules regarding investment choices, distribution options, and loan availability. If you choose to leave your savings with your former employer, remember to periodically review your investments and carefully track associated account documents and information.
Features
- Your former employer may not allow you to keep your assets in the plan.
- You must maintain a relationship with your former employer, possibly for decades.
- You generally are allowed to repay an outstanding loan within a short period of time.
- Additional contributions are generally not allowed. In addition to ordinary income tax, distributions prior to age 59½ may be subject to a 10% additional tax.
- RMDs, from your former employers plan, begin April 1 following the year you reach age 72 and continue annually thereafter, to avoid IRS penalties.
- RMDs must be taken from each QRP including designated Roth accounts aggregation is not allowed.
- Not all employer-sponsored plans have bankruptcy and creditor protection under ERISA.
If you choose this option, remember to periodically review your investments, carefully track associated paperwork and documents, and take RMDs from each of your retirement accounts.
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