You’ve been religiously contributing to your retirement funds for years. Your employer 401K may be your largest investment account. Understanding what you can do and should do with it are huge factors in your successful use of the retirement funds.
I retired in 2010. Here are a few things that surprised me when deciding how to take my distributions.
My company retirement funds were divided into two plans. When I first started, the company made all the contributions and it was all in company stock. Later, when they switched to a combination profit sharing/401k plan, the company shares just rolled into the profit sharing part. From then until my retirement date the company just contributed funds, and matching funds to the 401k.
Because of various lawsuits, the company had been selling stock in the first plan and replacing it with ‘diversified’ funds for about a decade – so that our retirement plan was not concentrated in company stock. Even during the 2008/2009 recession stock was redeemed and the proceeds placed into the ‘diversified’ funds. The stock price at the time was ¼ of the value it had been in 2007. I hated that I had no control over these sales. I wanted that stock in my control so I could manage it the way I thought best for my personal situation.
When you retire, you can choose what to do with your retirement account. Options include rolling your company profit sharing or 401K over to a traditional IRA (or a Roth if you were fortunate enough to have a Roth 401K), leaving it with the company plan sponsor or taking a lump sum distribution. However, if you take that lump sum distribution you probably will owe a lot in income tax the year you take it. There is one scenario where a lump sum can be beneficial though.
The Net Unrealized Appreciation (NUA) rule scenario.
There is a special tax rule (or was when I took distributions) called NUA which lets you avoid paying earned income tax rates on the net unrealized appreciation of the stock since it was placed in the plan for you. To benefit from this rule I had to take the stock as a lump sum distribution (not roll it over into an IRA). I will have to pay long term capital gains on the stock when I sell it. The capital gains can be significant and costly, but usually are cheaper than letting the stock appreciate in the account and paying income taxes on the appreciated value. For instance, my company stock was valued at about $6 a share, but now is worth over $115 a share. After talking it over with my accountant, we decided using this option would save me tax money in the long run – plus it let me put the stock into a taxable brokerage account that I control. An added bonus, if the tax laws don’t change, is that if I still have the stock in my brokerage account when it passes to my beneficiaries, the cost basis rises to the then current market value. Consult an accountant if you have company stock or other company securities in your retirement plan, to see what works best for your situation.
You may not be able to do a trustee to trustee rollover.
Since I have IRAs and have changed custodians on them, I am familiar with trustee to trustee rollovers – where I never touch the money or see a check. This is the easiest way to avoid a tax bite when changing custodians on your IRA.
I thought this is what I would do when I rolled over what the company called the ‘diversified’ fund of my Employee Stock Ownership plan (the money they got from selling my company stock) to an IRA, but it is not what did happen. My company insisted on sending me a check, which I then had to send along to the custodian of the new IRA I set up to handle the funds. This took a lot of coordination, done by me, to ensure that the check was made out correctly so the custodian could accept it. As a side note, I then had to decide what to invest the ‘diversified’ fund money in and set up some automatic transactions to make that happen over time.
Don’t plan on moving investments ‘in kind’.
I assumed I would be able to just transfer shares of the mutual funds in my 401K to another custodian when I took the funds out of the company plan and put them into an IRA. But my company’s 401K custodian insisted on cashing out the shares and sending along a check. The share class was institutional and institutional shares apparently can’t be held within an individual IRA. Back in 2010 our asset allocation called for international components and the 401k fund was filling a lot of that allocation. If you recall, international funds were doing very poorly back then. I ended up having to sell and invest again in another international fund.
You may have to start paying plan sponsor fees.
If you plan to just leave your investment with the company’s plan sponsor, not only will you be restricted to their choice of investments, but they also may start charging you the plan sponsor fee on your account. My company pays that fee if you are an employee. Not so much if you are retired! The sponsor would have started charging me one percent of the profit sharing balance each year.
Rolling the funds to an IRA with a low cost institution worked for me. I don’t pay any fee on my IRA at all.
If you are within a few years of retiring (or moving your money from your current plan sponsor to an IRA), talk to folks who have been there in your company to see what they have encountered. Ask to see the materials that the company sends to folks eligible for retirement to see what considerations might be a surprise to you.
Did you have surprises or unanticipated complexities when taking control of your retirement plan assets? If so, please share in the comments!