As retirement age draws near—and with the recent development that 2019 401(k) contribution limits will go up slightly from $18,500 to $19,000—now is the ideal time to consider smart strategies for drawing from your 401(k).
1. Don’t leave your job just yet.
If your job satisfaction is at a low point or if you’re simply itching for a new challenge, consider staying with your current employer until you are fully vested in their 401(k). This can sometimes require as many as five or six years of service. If you leave before that point, you risk losing thousands of dollars.
2. Merge the old and new.
Even though there are no required minimum distributions (RMDs) for your 401(k) with your current employer, distributions are mandatory for accounts with previous employers. Never fear—roll the old 401(k) into your current plan before age 70 1/2, and you’ll avoid this unpleasant scenario.
3. Don’t cash out.
You will likely work several jobs across the span of your career, potentially leaving one or more 401(k) accounts behind. Although these transitions may seem like great times for a cash boost, beware. If you take money out of your 401(k) account before age 59 1/2, you will incur a 10 percent early withdrawal penalty. Doing this also opts you out of compound interest, a valuable tool for creating a nest egg that can support your retirement lifestyle. A good alternative is to transfer the previous employer’s 401(k) into an IRA, which typically has low fees and a diverse range of investment options.
4. Wait to withdraw.
If you find yourself tempted to make an early withdrawal from your current 401(k) due to a need for cash, in addition to that early withdrawal penalty, you will also pay income tax on the distribution. An individual in the 25 percent tax bracket who makes a $5,000 early withdrawal will then owe $1,750 in penalties and taxes. Although there are exceptions—if you lose or leave your job at age 55 or later—this is generally not an ideal scenario.
5. Don’t be the middleman.
If you plan to roll your current 401(k) balance over to another 401(k) or an IRA, make sure the money gets transferred directly to that new account. If the transfer comes to you first, you will owe 20 percent for income tax. In addition, if you hold onto the entire transferred amount for longer than 60 days, it is considered a distribution and you may be assessed an early withdrawal penalty in addition to the income tax.
6. Watch your tax bracket.
Plan your distributions carefully so you can stay in a lower tax bracket. Your 401(k) distribution is calculated based on your particular bracket at that time. As such, make sure to only take distributions that approach the upper level of that bracket. Draw the remainder of what you need from cash savings, Roth, or after-tax investments. Also be mindful of splurge expenses, such as an epic vacation or new car, that can nudge your bracket upward. A hybrid of 401(k) withdrawals and the other aforementioned vehicles is ideal to enjoy your preferred retirement lifestyle while keeping a comfortable financial cushion.
7. Work a little longer.
If you are able to work past age 70 1/2, your current employer’s 401(k) won’t be subject to the RMDs that kick in for your other accounts. Unless you are the owner (or partial owner) of the company, in which case, this perk may not apply.
8. Wait to take social security.
Another way to potentially stay in a lower tax bracket and minimize your taxable income is to delay taking Social Security. The longer you wait, the higher your payout. You can increase these payouts by as much as a third in as little as four years.
9. Borrow from your 401(k).
If your plan allows you to borrow from your 401(k) balance, this may present a useful financial opportunity. With this option, you may have access to as much as 50 percent of the balance (with a limit of $50,000) and five years to pay it back. While borrowing from your 401(k) isn’t necessarily encouraged, it could potentially be better than taking a withdrawal, because no taxes or penalties apply to the amount of the loan as long as you meet your quarterly payments. However, this should only be considered if you need the funds on a short term basis.
10. When in doubt, ask a professional.
Although many of the above strategies are worth serious consideration in order to take full advantage of your 401(k), it is always prudent to consult a financial professional when managing investments.