How To Handle 401k Distributions

401k distributionYou’ve been contributing to a 401k plan for years. And, your employer was good enough to add some matching funds. But now that you’re getting ready to retire it’s time to start thinking about the distribution of that 401k plan. So what should you do with your 401k once you retire?

There are two sets of rules governing your 401k plan. Both the IRS and your plan administrator have a say in what you can do with the account. The IRS controls how your choices affect your taxes. The plan administrator has a say in how you invest and how you can withdraw assets.

If you’re 59 1/2 or older you can withdraw funds from your 401k without tax penalty. Under some circumstances you can withdraw a lump sum penalty free if you’re over 55. Note, you’re avoiding penalties, not ordinary income taxes. The penalty for early withdrawal is 10% of the amount withdrawn.

Some retirees want to delay taking withdrawals as long as possible. Mainly to help their savings compound without the negative effect of taxes. Generally it makes sense to delay taxes.

Beginning the year you turn 70 1/2 you must begin taking minimum distributions. The amount is related to your life expectancy. Your plan administrator can provide you with the IRS table. To get a rough estimate of your required distribution divide 1 by the number of years of your life expectancy. Then multiply that by the value of the assets in the 401k plan.

Once you retire, most financial advisors will recommend that you take your money out of the 401k plan. Either as a one time distribution or as a rollover into an IRA account. The reason is to avoid plan fees and to give you greater flexibility in investing your funds.

If you decide to keep your funds within the 401k plan you’ll need to adhere to their rules. Those rules will affect both your options for distribution and your investment choices. Check with your plan administrator to find out how to withdraw funds. Most will allow you to make periodic or regularly scheduled withdrawals. There may also be rules regarding when and how often you can change your distribution options. Some also have rules regarding minimum distributions.

As mentioned, withdrawals will be added to your taxable income unless they’re rolled over into a qualifying IRA.

For many retirees, rolling into an IRA is their best choice. You’ll have lower fees, more investment choices, similar distribution rules and still be compounding tax-free.

If you plan on taking your distribution in cash, you’ll need to do some tax planning. Taking a regular distribution will allow you to spread the taxes and keep you in the lower tax brackets. Taking a lump sum distribution could throw you into a tax bracket designed for the wealthy. Your distribution will also be reduced by a 20% withholding which you can apply to your next year’s tax bill.

A popular option is to take part or all of your funds in a distribution and purchase an annuity. There are various types of annuities. Retirees prefer ones that provide a guaranteed lifetime income. Proponents point out that with an annuity you can’t outlive your money. But you should recognize that not all annuities are indexed for inflation. Your monthly guarantee might look good today, but buy much less in 20 years if prices rise (and it’s likely they will).

No one choice is best for everyone. This might be the time to get some professional advice. The decision you make is the culmination of years of saving and will affect your finances for the rest of your life.

There are many variables to consider. How much you’ve saved. Your investment philosophy. Your income needs. Your expected longevity. Your tax situation. Even your children’s financial situation can affect your decision.


Stressful Time – Income Tax Time

Tax TimeIt’s often said that the winter holidays are the most stressful time of year, but I bet anyone who has to file an income tax return could easily argue against that contention. With mounting anxiety, Americans often procrastinate for weeks or months before rushing around to collect all the necessary paperwork they need to file. Finally they sit down to face the task – often unaware of which way their return will fall. Will they owe this year or get a tax refund?


The economic demands of our day make this season of stress even more challenging for many. With income barely meeting their needs and unexpected expenses straining an already tight budget, many people dread the thought of an additional tax bill. On the flip side is the relief felt when they find that they’ll be getting a refund check in the mail.


Knowing that the anxiety-inducing job of filing a tax return is inevitable simply means that postponing the task just adds to the stress. So no matter what you may expect, whether good or bad, the first step in easing the stress is to get down to business. Then, once you know the outcome, you’ll have time to decide how to ease the burden of a tax bill or the best use for a tax refund.


You owe the Taxman!

Taking the worst-case scenario first, finding that you owe the IRS. First off, don’t panic even if the amount is beyond your ability to pay within the 10 days allotted after the IRS has made the assessment of what you owe. You need to be proactive in finding a solution while protecting your assets. No one will come to arrest you, but you will begin to get threatening notices before you’ll be contacted by a revenue officer. Quick action will help prevent the harassment and additional penalties and interest.


The first question to ask is whether you actually owe the money. A simple mathematical error can mean the difference between a refund and a tax bill. Thoroughly review the forms you filed for discrepancies. Better yet, pay a professional tax preparer to go over your returns again. If you discover that you definitely owe the IRS, you have multiple options to repay. Some will reduce the net amount owed; others will increase your overall payout.


An installment plan is the option used by taxpayers who owe less than $25,000. Fill out IRS Form 9465, a straight forward, form used to request a monthly payment plan. Provide the total amount you owe, how much you are able to apply to the tax bill right now and the amount you can pay each month. The IRS then can adjust the agreement or offer other arrangements.


Other options for taxpayers who owe money include account receivable and bank levies, wage garnishment, penalty abatement and what’s called an ‘offer in compromise’ which lowers the amount owed. However you decide to address your obligation to the IRS, the sooner you pay it off, the less you’ll pay in interest and penalties.


Whoopee! A Refund!

While celebrating may be overkill, taxpayers who are getting a tax refund can breathe a sigh of relief for dodging a tax bill. They now have an opportunity to make wise use of a tax windfall.


  • Invest/Save:One of the most fiscally responsible uses would be to deposit it into a 401k or other investment fund that earns interest.
  • Pay off Debt:While increasing your investment accounts has obvious benefits, the decision to pay down debt is a stress reliever for anyone who carries a balance. Lower debt has the potential to move your credit score in a positive direction making future borrowing easier.


Experiencing less stress during tax season comes when you pursue excellent financial management all year long. Avoid becoming overwhelmed by consistently burning the midnight oil and sacrificing entire weekends to work. Focus on balancing work and your private life. Set financial goals and celebrate milestones.