Are you thinking about retiring early? Maybe you’ve accumulated enough savings to retire in your 50s. Or maybe you’re facing a health issue or job loss that’s pushing you into retirement. No matter the reason, early retirement can present a number of unique challenges.
One of the biggest issues that early retirees face is taking distributions from their qualified retirement accounts, such as IRAs and 401(k) plans. These accounts are tax-deferred, which means there are no taxes on growth as long as the funds stay inside the account. However, distributions may be taxed as income. Additionally, if you withdraw funds from a 401(k) or an IRA before age 59½, you could face a 10 percent early distribution penalty.
The early distribution penalty clearly presents a challenge if you retire before age 59½. Much of your retirement assets may be in your 401(k), so it may be impossible for you to cover your living expenses without dipping into those funds.
Fortunately, there are ways in which you can access those funds. However, you need to plan your approach carefully. If you make a misstep, you could pay excessive taxes and penalties. Below are three common missteps many retirees make when taking early distributions from their 401(k) plans. Be sure to avoid these as you develop your plan.
Cashing out the entire plan.
As soon as you separate from service from your employer, you have the option to cash out your 401(k) plan. This could be tempting. After all, you may have a significant amount of assets in your plan. If you cash out early, you may receive a large lump sum that you can use to fund your biggest retirement goals.
However, a cash-out could bring unwanted consequences. One is that the entire distribution will count as taxable income. That could push you into a higher tax bracket and inflate your tax bill for that year. You also may face an early distribution penalty on the full amount. The combination of taxes and penalties could erode your savings.
Rolling over to an IRA after 55.
Retirees are often advised to roll their 401(k) plans into an IRA so they can take advantage of greater control and investment flexibility. However, an IRA rollover may not be the best move if you leave your employer after age 55.
The IRS allows for penalty-free 401(k) distributions if you leave your job after age 55. You still have to pay taxes on the withdrawals, but not the 10 percent penalty. The catch is that this rule applies only to the 401(k) for the employer you left after age 55. It doesn’t apply to IRAs or 401(k) plans from previous employers. If you roll your plan into an IRA, you may not be able to take advantage of this opportunity.
Rolling company stock into an IRA.
Do you have a substantial amount of appreciated company stock in your 401(k) plan? Before you roll that stock into an IRA, you may want to consider other options. The IRS allows for special treatment of company stock held in a 401(k) plan.
The rule, known as net unrealized appreciation, or NUA, allows you to distribute that stock from the plan and carry over the basis. You can then sell the stock and pay capital gains taxes on the growth. If you roll the stock into an IRA and then take a distribution, however, you’ll be taxed on the full amount as income. Your income tax rate is likely to be higher than the capital gains rate, so it may make sense to keep your company stock out of any IRA rollover.
A financial professional can help you develop the most appropriate income strategy. Contact us today at MasterPlan Retirement Consultants. We can help you analyze your needs and develop a plan. Let’s connect soon and start the conversation.
Licensed Insurance Professional. This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
Investment advisory services offered through MasterPlan Retirement Consultants, Inc. a Registered Investment Advisor in the state of Georgia. Insurance products & services offered through Fricks and Associates, Inc. MasterPlan Retirement Consultants, Inc. & Fricks and Associates, Inc are affiliated companies.
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