Does much of your retirement savings exist inside your company’s 401(k) plan? You’re not alone. The 401(k) is a widely-used retirement savings vehicles. Your 401(k) plan likely offers tax-deferred growth and matching employer contributions, the combination of which can power your retirement asset accumulation.
When and if you ever leave your employer, you may face a choice about what you should do with your vested plan balance. Conventional wisdom is to roll the 401(k) balance into an IRA. When you do a rollover, you avoid taxes and penalties, and you may gain access to a wider menu of investment options.
A rollover isn’t always the best strategy, though. There are certain instances in which you may be best served by keeping your balance in the 401(k) plan. Below are three such instances. If you might face any of these situations in the future, you may want to consider your options carefully before moving forward.
You plan to retire early.
Qualified plans such as 401(k)s and traditional IRAs are popular because they offer tax-deferred growth. That means you don’t pay taxes on your investment growth as long as the funds stay inside the account. Instead, you pay income taxes when you take distributions. The deferral of your taxes may help your assets accumulate at faster rate than they would in a taxable account.
The trade-off for this tax deferral is that you must use the accounts for retirement purposes. That means you generally aren’t allowed to take distributions from your qualified accounts until age 59½. If you take a distribution before that point, you could face a 10 percent early distribution penalty.
Participants in a 401(k) plan have an exception to the early distribution penalty, though. If you leave your employer and stop using the 401(k) after age 55, you can take distributions without paying the penalty. You will still pay taxes on the distributions, but you’ll avoid the early distribution penalty. You may not have the same flexibility if your roll your 401(k) funds into an IRA.
You own appreciated company stock in your 401(k) plan.
Many companies offer company stock as an investment option in their 401(k) plans. If you have purchased company stock in the plan over a long period of time, that stock may have appreciated in value.
An IRA rollover can create a tricky tax issue with regard to your appreciated company stock. All distributions from a traditional IRA are taxed as income. That means you will face income tax rates on your company stock appreciation.
However, if you keep the stock in your 401(k), you could use a strategy known as net unrealized appreciation. That means you can distribute the stock from the plan and pay income tax on the basis, while paying the capital gains rate on the accumulation. That could lead to a reduced tax bill. A tax professional can help you further explore this option.
You plan on working beyond age 70 ½.
Don’t plan on retiring anytime soon? More and more workers are choosing to work into their late 60s and even their 70s. If you’re one of those workers, you could benefit from keeping your funds in your 401(k). Many qualified plans, with the exception of the Roth IRA, require you to take mandatory distributions starting at age 70½.
However, there’s an exception to this if you continue to work past age 70½ and are a participant in a 401(k) plan. You aren’t required to take distributions, and you can even keep making contributions and receiving employer matching contributions. If you roll your funds into an IRA, you will be required to take distributions at age 70½, regardless of whether you are still working.
Have questions about planning for your financial future? Let’s talk about it. We welcome the opportunity to help you analyze your needs and goals, and then develop a strategy. Let’s connect soon and start the conversation.
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