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 doesnt count as a taxable event.
Withdrawing Income And Rebalancing Your Portfolio All In One
Its smart to plan your withdrawals at the same time that you rebalance your portfolio. Once youve decided which asset class or classes need trimming, look at your lowest-rated holdings for potential sales.
As a simplified example, lets say that youre a new retiree with the following moderate portfolio. You intend to withdraw 4 percent, or $40,000, at the end of the year.
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Other Important Financial Goals To Consider
You should keep a few other things in mind as you decide how much to contribute to your 401 based on your own unique financial situation.
- Do you have a formal estate plan with a will and other critical papers ?
- Can you cover health care expenses? Make sure youre putting enough into your health savings account , both now and in the future, to cover medical expenses if you have a high-deductible health plan with an HSA combo.
- Do you have proper disability insurance coverage to protect you and your family if you miss work for six months or more due to illness or injury?
- Do you have long-term care plans in place if youre nearing retirement?
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Where To Put My Money Before The Market Crashes
Many people are worried about the stock market crash. They think their money will disappear overnight if they dont put it in the right place. While its true that the stock markets can be volatile, there are some steps you can take to protect your money.
- One option is to invest in bonds. Bonds are debt securities that governments and corporations issue. They typically have a fixed interest rate and a maturity date, which is the date when the bondholder will receive their money back.
- Another option is to invest in gold. Gold is a precious metal that has been used as a store of value for centuries. As a result, it tends to hold its value during economic turmoil.
- Finally, A fixed index annuity is an insurance product that offers a guaranteed rate of return, plus the potential for additional growth based on the performance of a stock market index. If the market crashes, your investment in a fixed index annuity will not decrease in value. The guaranteed rate of return provides a floor for your investment, and the index-linked growth potential gives you the markets upside without the downside risk.
So if youre worried about the stock market crashing, consider investing in bonds, gold, or indexed annuities.
Which Assets Should You Draw From First
You may have assets in accounts that are taxable , tax-deferred s, and tax-free . Given a choice, which type of account should you withdraw from first?
The answer isâit depends.
- For retirees who dont care about leaving an estate to beneficiaries, the answer is simple in theory: withdraw money from taxable accounts first, then tax-deferred accounts, and lastly, tax-free accounts. By using your tax-favored accounts last, and avoiding taxes as long as possible, youll keep more of your retirement dollars working for you.
- For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement planning with your estate plan. For example, if you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will. A step-up in basis is used to calculate tax liabilities for your beneficiaries.
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When Safer Assets Make Sense
Not all 401 investment menus offered by employers are the same. So you might not have all of these choices, particularly a stable value fund. It depends on whether your employer chooses to provide them.
Its also important to consider whether safer assets even make sense given your personal situation.
If youre 25 years old and you have a long runway before you reach retirement at 65, I would say dont consider a stable value fund, Pottichen said.
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It’s Sometimes Possible To Get A Tax Deduction But That May Not Be Worth It
The government allows you to claim a tax deduction if your 401 or other retirement plan has lost value, but there are rules you must follow. First, you must have basis. In this case, basis refers to nondeductible contributions you’ve made. Deductible contributions — those that reduce your taxable income for the year — do not count. You haven’t paid any taxes on that money so far, so the government is not going to give you a tax deduction on the amount you lost.
You also must close all retirement accounts of the same type in order to calculate the loss. So if you’re trying to claim a loss on your 401, you must close all of your 401s. Then you total your nondeductible contributions and the current value of the accounts, and you can write off the difference if the current value of the accounts is lower.
But this is inconvenient for two reasons. First, if you withdraw money from your 401 before age 59 1/2, you pay a 10% early withdrawal penalty. This may negate some of the benefit you get from writing off the loss. Second, if you take the money out of your 401, you’re giving up the tax advantages it offers and your money will no longer grow as quickly unless you invest it in something else.
For these reasons, it’s not wise to claim a tax deduction on a 401 loss unless you’re older than 59 1/2 and plan to use the money to cover your retirement expenses in the near future anyway. Otherwise, try one of the suggestions above.
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Leave Your Retirement Savings Alone
After age 59½ you can begin to make penalty-free withdrawals from your traditional retirement plans and IRAs. With a Roth IRA, you can withdraw your contributionsbut not any earnings on thempenalty-free, at any age.
There is also an IRS exception, commonly known as the Rule of 55, that waives the early-withdrawal penalty on retirement plan distributions for workers 55 and over who lose or leave their jobs. Its complex, so speak with a financial or tax advisor if you are considering using it.
But just because you can make withdrawals doesnt mean you shouldunless you absolutely need the cash. The longer you leave your retirement accounts untouched from some of them), the better off you are likely to be.
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The Art Of Balancing Your Portfolio
A well-diversified 401k plan requires regular maintenance or asset allocation for best performance. But over time, market prices might affect the desired asset distribution and fail to meet long-term retirement goals. Thats when the 401 needs rebalancing.
The assets investors initially set for 401s can change direction over time, depending on the overall returns. For example, if the required stock vs. bond ratio is 60:40, a bull market can change the balance after some time.
Presuming the percentage of stocks reaches 65% or 70%, the risk of losses in a market crash is also more significant. Investors must sell stocks and buy bonds to restore the balance, thus protecting 401 before a crash.
Target-date funds are the easiest way to rebalance a portfolio. Accountholders who want more control over their investments should regularly check their fund balance and consult financial advisors for a more tax-efficient approach.
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And Ira Planning That Works For You
You can always contribute to both an IRA and 401. However, if your income exceeds the phase-out limit , then you will likely want to couple a traditional 401 with a Roth IRA, in order to maximize the tax benefits of each respective account.
To learn more about retirement contributions, 401s, or IRAs, we recommend checking out our retirement planning center.
When Not To Transfer To An Ira
You now know some of the benefits of moving your 401 to an IRA. But control over your money isnt the only thing that matters, and you may have other priorities. Its impossible to list every potential pitfall, but here are just a few examples of when I suggest that clients might want to leave funds with their employer.
Between age 55 and 59.5
When youre at least 55 years oldbut not yet 59 1/2 years oldyou might want to leave at least some of your money in the 401 plan. 401s allow you to pull money out without penalty after age 55 . IRAs, on the other hand, require that you wait until age 59 ½ to avoid an early-withdrawal penalty of 10% on certain distributions. There are always exceptions and workarounds, but those are the basic rules. If you intend to spend your 401 savings between the ages of 55 and 59 1/2, keep this in mind before making a transfer.
Some Government Workers
If you worked for a federal, state, or local government, be sure to explore your options. Those with 457 plans can potentially avoid the early-withdrawal penalty thats commonly associated with 401 and similar plans. Plus, some public safety workers can avoid early withdrawal penalties from a retirement planincluding the TSPas early as age 50.
Roth Conversions
NUA Opportunities
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How Can A Stock Market Crash Affect Your 401
One of the best things about 401 is that it gives employees the freedom to invest on their terms. But even with such an advantage, a crash can affect savings. Thus, it helps to understand where to put 401 before the market crashes and why.
Many investment options for the 401 retirement plan include stocks, bonds, and cash.
Often, in earlier stages of employment, stocks account for most of the 401 investments. With proper asset allocation, the stock-bond ratio should change over the years to mitigate risks.
However, stocks remain a popular investment choice thanks to their high returns. While thats a tremendous advantage when prices follow an upward trajectory, an unexpected stock market crash can do a lot of damage.
The 2008 financial collapse is one of the cleanest examples of the markets devastating impact on corresponding 401 retirement plan assets. More than 21 million participants endured changes in average 401 balances from January 1, 2008, to January 20, 2009. And the only distinction, depending on the participants account balance, was the amount lost.
The best-case scenario is suffering losses that the employee can recover from in the following years. The worst-case scenario is wiping out years, even decades worth of savings. So, its crucial to keep a close eye on the different investment options to avoid or cut down potential losses over a stock market crash.
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Spread 401 Money Equally Across Available Options
Most 401 plans offer some version of the choices described above. If they dont, a fourth way to allocate your 401 money is to spread it out equally across all available choices. This will often result in a well-balanced portfolio. For example, if your 401 offers 10 choices, put 10% of your money in each.
Or, pick one fund from each category, such as one fund from the large-cap category, one from the small-cap category, one from international stock, one from bonds, and one that is a money market or stable value fund. In this scenario, youd put 20% of your 401 money in each fund.
This method works if there are a limited set of options, but requires much more time and research if there are an array of options. In addition, it’s not as fail-safe as the first three because the asset mix may not be suitable for your retirement goals, and you have to rebalance the portfolio to maintain a certain percentage of each asset category over time.
When possible, it is always recommended that you complete an online risk questionnaire or consult a knowledgeable investment professional before haphazardly choosing stock investments that may lose you money.
Option : Keep Your Savings With Your Previous Employers Plan
If your previous employers 401 allows you to maintain your account and you are happy with the plans investment options, you can leave it. This might be the most convenient choice, but you should still evaluate your options. Each year, American workers manage to lose track of billions of dollars in old retirement savings accounts, so you should make sure to track your account regularly, review your investments as part of your overall portfolio and keep the beneficiaries up to date.
Some things to think about if youre considering keeping your money in your previous employers plan:
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Common Pitfalls Of Using Your 401 After Retirement
You ultimately have three options for how to use your 401 after retirement: Receive your funds, keep them intact, or move them to a different type of retirement account. The ideal way to use your retirement plan depends on your financial situation and how you want to use your money, so consider all options carefully.
Failure to conduct a thorough review of retirement fund options can cost you hundreds or thousands of dollars. It can also cause you to face tax penalties or miss out on other potentially high-value investment opportunities.
Meeting with an independent investment advisor can provide an excellent starting point for getting the most value out of your 401. They can help you assess the pros and cons of the myriad ways to use your retirement funds. They can also produce a personalized plan to ensure you can accomplish your financial goals in retirement.
Understanding The Different Investing Options
The average 401 plan provides about 19 different investment options to choose from. Unless the plan has a default investment option, your contributions could sit in your 401 as cash without being actually invested in anything.
If your contributions are automatically invested in a particular fund, you can always change what your money is invested in. If your 401 plan has an online portal, then you can research different funds and move your money as you please. If not, youâll have to contact your planâs custodian to facilitate moving your money to other investment options.
Your 401 planâs summary plan description will outline the default investment options, the other available investment options, and how to move your money to various funds. Some of the most common funds provided in 401 plans are target-date funds, mutual funds, index funds, and bond funds.
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Consider 401 Alternatives Like An Ira
You dont have to limit your savings to your 401k. You may also be able to save in other retirement vehicles, like a traditional IRA or Roth IRA.
Can you contribute to 401k and IRA plans simultaneously? For example, if youre already contributing to a 401k plan at work, you may be wondering if you can also save money in an IRA.
Or maybe you opened an IRA in college, but now youre starting your career and have access to a 401k. Does it make sense to keep making contributions if youll soon be enrolled in your employers retirement plan?
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