Building and Protecting Your Nest Egg
How Career Moves Can Affect Your Investments
by Steven Audino
The days when an employee would spend his or her entire career with the same company appear to be all but gone. Nowadays, beyond simply changing jobs over the course of a career, many workers even take on an entirely new career before they finally reach retirement. When you make a job change, one of the biggest challenges you may face could be deciding what to do with the assets you’ve built up in your former employer’s retirement plan.
Unfortunately, many people look at these funds as a free gift when they change employers, and they choose to take a cash payment and spend it. Keep in mind one of the most important sources of your retirement income is the payments you receive from company retirement plans. By taking the money out in cash, you eat away at this valuable source of retirement income.
Something to Think About
Instead of taking the cash, you may want to consider rolling the money from your company-sponsored plan into an IRA. A direct rollover – where the funds from your company plan go directly into an IRA – is a simple way to allow these assets the opportunity to continue to grow tax-deferred, and will help you avoid the temptation to spend these important funds on other things.
Moving from job to job may not be the only change you are considering. IRA rollovers can also prove useful if you decide that instead of just changing jobs, you want to retire. If you’re younger than 59½ and would like to take withdrawals from a retirement account, you may be able to avoid the IRS 10 percent early withdrawal penalty as long as the withdrawals qualify for certain exceptions. Let’s take a look at an example to help illustrate the options.
Take John, for Instance
John is 58 years old, and would like to retire early to join his wife Carol, 57, who retired two years ago. Currently, their modified adjusted gross income (MAGI) is $98,000, but if John retires that figure will drop to $48,000. This should still be enough to cover all their expenses, except their mortgage payments. John has a 401(k) balance of $300,000 and an investment portfolio worth another $125,000, while Carol has an IRA with a current value of $25,000. They are considering taking $100,000 out of their retirement nest egg to pay off their mortgage, but if they’re not careful, doing so could require them to pay both income taxes and the IRS 10 percent early withdrawal penalty on the amount they withdraw.
One option that may help would be to take a $100,000 withdrawal from John’s 401(k) to pay off the mortgage. This would result in taxable income, but since he would be older than age 55 at retirement, John would qualify for a special “55 or over” exception, meaning he would not face the early withdrawal penalty. The remainder of his 401(k) balance could still be rolled into an IRA.
As another alternative, John could roll the money from his 401(k) into an IRA first. He could then use one of three IRS-approved withdrawal methods to take “substantially equal periodic payments” from the IRA without an IRS penalty, and use that money to make their monthly mortgage payments. While these withdrawals would be taxable, this strategy could still allow for greater tax deferral because the entire 401(k) distribution could be rolled over.
As you can see from these examples, it’s important to know what your options are and you may need to consult with financial professionals – including your tax advisor – to sort them all out. Whether it’s your first job change or your last, your retirement nest egg needs to be handled with care. Consider your alternatives so you can make good decisions to keep your savings in line to meet your needs.
Steven D. Audino, MBA is with Wells Fargo Advisors in Melbourne and can be contacted at (321) 409-4425.