If you’re nearing retirement, have retired, or recently left your company for any reason, you should create a 401(k) game plan. Know how your investment options can expand, how to avoid tax traps, and what you’ll do with any company stock in your 401(k). There are many options, and the right one depends on your age, retirement goals, and overall financial situation – here’s what to consider.
You Can Roll Over Your 401(k) Into an IRA
Although you may have the option to cash out of your old 401(k), you will pay tax on those funds at ordinary income rates. This could significantly increase your tax burden and could mean losing out on years of tax-deferred growth in the future. Instead, you can rollover your old 401(k) into an IRA. This way, you don’t pay tax on what you rollover and can continue making tax-deferred contributions if you earn income. And, you can potentially gain access to more investment options so that you can pursue an investment strategy that better suits you.[1] As you get close to retirement, consider your asset allocation, and learn about alternative investment options – with an IRA, you can invest in practically any stock, mutual fund, ETF, bond, real estate, or security.
You Can Convert Part or All of it to a Roth IRA
Another option is converting part or all of a 401(k) into a Roth IRA. This would mean paying tax on the amount you convert since you’re moving it from a pre-tax account to an after-tax account. Some of the advantages of doing this are enjoying tax-free withdrawals from a Roth IRA in the future and avoiding Required Minimum Distributions (RMDs). And, although your income may have been too high to allow you to contribute to a Roth IRA in the past, Roth income limitations do not apply to this conversion. Keep in mind that you must wait five years to withdraw penalty-free from a Roth after converting.[2]
Consider What to Do with Company Stock
If you have company stock in your 401(k), you’ll need to decide what to do with it when you retire or if you roll your 401(k) into an IRA. If you do roll over your company stock, consider NUA (Net Unrealized Appreciation). The NUA is the difference between the value of the company stock at the time it was purchased or given to you and what it’s worth when it’s transferred out of the 401(k). If you transfer it to an IRA, you won’t pay tax immediately, but you’re liable to pay income tax on the stock’s full NUA when you sell it. Alternatively, if you transfer it to a brokerage account, you’ll pay income tax on it immediately on the cost basis, and when you sell it, you’ll pay long-term capital gains. Also, consider how much the stock has increased in value, the financial standing of your company, and if you would have as much invested in it if you didn’t work there.
A financial advisor can discuss more options and reasons to have a 401(k) strategy. If you would like to know about your 401(k) options, sign up for a complimentary financial review. We can work with you to decide on allocation and contribution strategies, help you create a financial plan after you stop receiving a paycheck, and provide options for turning your savings into lifetime retirement income.
