Stay In A Lower Tax Bracket
When taking 401 withdrawals, you should try to keep the taxable income in a lower tax bracket to reduce the tax bill. You can achieve this by taking distributions up to the upper limit of your tax bracket to avoid falling into the next tax bracket with a higher tax rate.
For example, a married couple whose income is below $81,050 falls in the 12% tax bracket. A higher income above $81,051 pushes the saver into the next tax bracket with a 22% tax rate, which results in a higher tax bill. An account holder can limit the amount of 401 withdrawals by taking a combination of 401 and other sources such as Roth savings and cash savings.
The 401 Withdrawal Rules For People Between 55 And 59
Most of the time, anyone who withdraws from their 401 before they reach 59 ½ will have to pay a 10% penalty as well as their regular income tax. However, you can withdraw your savings without a penalty at age 55 in some circumstances. You cannot be a current employee of the company that runs the 401, and you must have left that employer during or after the calendar year in which you turned 55. Many people call this the Rule of 55.
If youre between 55 and 59 ½ years old and you are considering a 401k withdrawal from an old employer, you should keep a few things in mind. For starters, doesnt matter why your employment stopped. Whether you quit, you were fired, or you were laid off, you can qualify for a penalty-free withdrawal. However, you need to meet the age requirement and your employment must end in the calendar year you turn 55 or later.
These rules for early 401 withdrawal only apply to assets in 401 plans maintained by former employers. The rules dont apply if youre still working for your employer. For example, an employee of Washington and Sons usually wont be able to make a penalty-free withdrawal before they turn 59 ½. However, the same employee can make a withdrawal from a former employers 401 account and avoid the penalty when he or she turns 55.
Option : Cash Out Your 401
When you leave your employer and return to your home country, you can also cash out your 401. But if you do are not 59 ½, the withdrawal will be taxable and you may be subject to a 10% early withdrawal penalty on the distribution.
Between all three options, we recommend that individuals returning to their home countries pursue Options 1 or 2: leave their 401s with their former employer or do a rollover to an IRA.
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How Do I Move My 401k Without Paying Taxes
Heres how to minimize 401 and IRA withdrawal taxes in retirement:
What Is The Rule Of 55
Under the terms of this rule, you can withdraw funds from your current jobs 401 or 403 plan with no 10% tax penalty if you leave that job in or after the year you turn 55. It doesnt matter whether you were laid off, fired, or just quit.
The distributions are not completely tax free: Like all withdrawals from a traditional 401 or 403, you do have to pay income tax. Only the 10% tax penalty is bypassed in this scenario.
In addition, note that employers are not obliged to allow early withdrawals and, if they do allow them, they may require that the entire amount be taken out in one lump-sum withdrawal. This could expose you to a higher income tax.
This rule applies to current not former 401 or 403 plans. The government does not permit penalty-free withdrawals before 59.5 from plans you had with a previous employer. If you want access to that money under the rule of 55, you would have to transfer those funds into your current 401 or 403 plan.
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Why Planning 401 Distributions Matters
Your 401 from your US employer can be an asset and a source of income in your retirement, even if you have returned to your home country.
If you are leaving the US, its highly recommended that you that you make an informed decision about what to do with your 401. Take steps to examine your retirement cash flow requirements, pursue diversified investments in both international and US stocks, and be strategic about minimizing taxes in the future.
Cash Out Current 401k Assets To Invest In Real Estate
It is true! QDROs are one of the exceptions where you are able to use to get at your money without a penalty. If you want to invest in after-tax real estate from your current employers 401k, use a QDRO and cash out to your spouses bank account. Of course, ordinary taxes are due when cashing out, but as the funds were accessed via a QDRO, there is no 10% penalty.
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What Is A 401 Rollover
A 401 rollover is when you take funds out of your 401 account and move them into another tax-advantaged retirement account. You can roll a 401 over into an individual retirement account or into another 401, most commonly when you get a new job with a new retirement plan. Either way, you should understand the best 401 rollover options for your particular situation.
Rollover To An Ira Can Mean Tax
If you rollover to an IRA you may have a wide choice of investment options, including choices that employers might not offer, such as mutual funds, annuities and bank CDs. This option allows your funds to continue growing tax-deferred. And you can simplify your financial life by moving the account to a company where you already have funds or even into an existing IRA.
If you choose a Traditional IRA, you won’t pay any taxes when you conduct a rollover. If you roll money into a Roth IRA, you’ll be taxed on the money going into the account, but pay no federal income taxes when you withdraw the money . Money from a Roth 401k can be rolled into a Roth IRA tax-free.
When rolling over a 401k balance into an IRA it’s important to do a full comparison on the differences in the guarantees and protections offered by each respective type of account as well as the differences in liquidity/loans, types of investments, fees and any potential penalties.
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Where Should You Transfer Your 401
You have several options on what to do with your 401 savings after retirement or when you change jobs. For example, you can:
The right choice depends on your needs, and thats a choice everybody needs to make after evaluating all of the options.
Want help finding the right place for your retirement savings? Thats exactly what I do. As a fee-only fidicuary advisor, I can provide advice whether you prefer to pay a flat fee or youd like me to handle investment management for you, and I dont earn any commissions. To help with that decision, learn more about me or take a look at the Pricing page to see if it makes sense to talk. Theres no obligation to chat.
Important:The different rules that apply to 401 and IRA accounts are confusing. Discuss any transfers with a professional advisor before you make any decisions. This article is not tax advice, and you need to verify details with a CPA and your employers plan administrator. Likewise, only an attorney authorized to work in your state can provide guidance on legal matters. Approach Financial, Inc. does not provide tax or legal services. This information might not be applicable to your situation, it may be out of date, and it may contain errors and omissions.
Defer Taking Social Security
If you have taken a 401 withdrawal, you should consider deferring your Social Security benefits to keep your taxable income in a lower tax bracket. Taking both distributions at the same time increases your taxable income, hence increasing your income tax bill.
If the 401 withdrawals are enough to meet your needs, you can delay taking social security benefits until 70 years. Not only does this strategy minimize tax on 401 withdrawal, but it also increases your social security payments by up to 28%. This strategy works if you delay taking social security benefits after reaching the full retirement age, which ranges between 65 to 67 years.
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Our Take: When Can You Withdraw From Your 401k Or Ira Penalty
There are a number of ways you can withdraw from your 401k or IRA penalty-free. Still, we recommend not touching your retirement savings until you are actually retired. Compounding is a huge help when it comes to maximizing your retirement savings and extending the life of your portfolio. You lose out on that when you take early distributions. To see how much compounding can affect your 401k account balance, check out our article on the average 401k balance by age.
We understand that its always possible for unforeseen circumstances to arise before you reach retirement. Being aware of the exceptions allows you to make informed decisions and possibly avoid paying extra fees and taxes.
To take control of your finances, a good place to start is by stepping back, getting organized, and looking at your money holistically. Personal Capitals free financial dashboard will allow you to:
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
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.
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Rolling Over Your 401 To An Ira
You have the most control and the most choice if you own an IRA. Unless you work for a company with a very high-quality planthese are usually the big, Fortune 500 firmsIRAs typically offer a much wider array of investment options than 401s.
Some 401 plans have only a half dozen funds to choose from, and some companies strongly encourage participants to invest heavily in the company’s stock. Many 401 plans are also funded with variable annuity contracts that provide a layer of insurance protection for the assets in the plan at a cost to the participants that often run as much as 3% per year. Depending on which custodian and which investments you choose, IRA fees tend to run cheaper.
With a small handful of exceptions, IRAs allow virtually any type of asset: stocks, bonds, certificates of deposit , mutual funds, exchange traded funds, real estate investment trusts , and annuities. If you’re willing to set up a self-directed IRA, even some alternative investments like oil and gas leases, physical property, and commodities can be purchased within these accounts.
If you opt for an IRA, then your second decision is whether to open a traditional IRA or a Roth IRA. Basically, the choice is between paying income taxes now or later.
What Spouses Should Know
If you are the spouse of someone who plans to roll over their 401 balance to an IRA, be aware that you’d lose the right to be the sole heir of that money. With the workplace plan, the beneficiary must be you, the spouse, unless you sign a waiver.
Once the money lands in the rollover IRA, the account owner can name any beneficiary they want without their spouse’s consent.
Here’s another potential misstep: Making a withdrawal from your 401 to give to your ex-spouse as dictated in a divorce agreement. That won’t work the money will be considered a distribution to you, subject to taxation, as well as potentially a penalty if you’re under age 59½.
In a divorce, retirement assets that are awarded to the ex-spouse can only be distributed penalty-free via a qualified domestic relations order, or QDRO. That document is separate from the divorce decree and must be approved by a judge.
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Next Steps To Consider
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Recently enacted legislation made a number of changes to the rules regarding defined contribution, defined benefit, and/or individual retirement plans and 529 plans. Information herein may refer to or be based on certain rules in effect prior to this legislation and current rules may differ. As always, before making any decisions about your retirement planning or withdrawals, you should consult with your personal tax advisor.
The change in the RMD age requirement from 70½ to 72 only applies to individuals who turn 70½ on or after January 1, 2020. Please speak with your tax advisor regarding the impact of this change on future RMDs.
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided the 5-year aging requirement has been satisfied and one of the following conditions is met: age 59½ or older, disability, qualified first-time home purchase, or death.
Be sure to consider all your available options and the applicable fees and features of each before moving your retirement assets.
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Planning Out The Timing Of Your Withdrawals
The timing of your early withdrawals is important, says Dave Lowell, certified financial planner and founder of Up Your Money Game.
If you were employed for most of the year and had a relatively high income, then it makes sense to not withdraw money under the rule of 55 in that calendar year, since it will add to your total income for the year and possibly result in you moving to a higher marginal tax bracket, Lowell says.
The better strategy in that scenario may be to use other savings or take withdrawals from after-tax investments until the next calendar rolls around. This may result in your taxable income being much lower.
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When Leaving Your Job You Can Typically Cash Out Your 401 Or Roll It Over Into A Different Retirement Account Certain Options Can Make You Much Richer
Both a 401 and IRA are tax-advantaged retirement accounts, but they work differently. 401s are sponsored by employers and often offer limited investment options. IRAs aren’t linked to employment. They can be opened with any brokerage firm or other financial institutions and have a wider variety of investment selections, but require more hands-on management.
Because 401s are offered through employers, you’ll need to determine what to do with yours when you leave your job. Your options include:
- Leave it invested
- Rollover to a new 401
- Rollover to an IRA
There are plenty of pros and cons to these options, but let’s take a close look at when rolling your workplace 401 into an IRA may make sense for you.
How Are 401 Withdrawals Taxed
When you take distributions from a regular or traditional 401, they are treated as normal income and subject to income tax. Since your contributions to traditional 401 were paid with pre-tax dollars, you are liable to pay taxes when you start taking your distributions.
When you withdraw money from your traditional 401, the IRS considers the withdrawal as ordinary income and taxed as such. Therefore, the tax you pay on your withdrawal will depend on your tax bracket the higher the distribution, the higher the tax payable will be. Moreover, if you withdraw from your 401 before you reach 59 ½ years, you may also be charged a 10% penalty on the distribution.
However, with a Roth 401, your distributions have a different tax treatment. Since your contributions to a Roth 401 are made with after-tax dollars, its unlikely that youll be taxed on your distributions, that is, if its a qualified distribution. A qualified Roth 401 distribution is when:
- your Roth account has sufficiently aged it should meet the five-year aging rule
- you are old enough to make a withdrawal without a penalty you can receive a tax-free distribution treatment once you reach the age of 59½
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