There is enough information about the need to save for retirement to fill your head for a lifetime. The idea behind all that saving is to eventually use the money for retirement. Therefore, it would seem that it is just as important to understand the rules about taking money out as it is to know how to put the money in. Taking a qualified distribution can involve many choices, and if you aren’t careful, you could make decisions that result in long-term negative effects.
Are you eligible? First, there are some rules about who is eligible to take money from an employer-sponsored, qualified retirement account like a 401(k), 403(b), 457 or Thrift Savings Plan. You’ll want to check your plan document for any specific plan rules for your company, but generally you must be at least 59 ½. Some companies place restrictions on taking the money out while you are still working, even if you’re older than 59 ½, so do your research so you’re not surprised when you need the money most.
Do you have an outstanding loan? If you leave your company with an outstanding loan from your retirement account and you’re under 59 ½, you will need to pay the outstanding loan amount back to your account. If you don’t, you’ll be responsible for the taxes on the outstanding amount and a penalty for early withdrawal when you file your taxes. Investors who leave an employer with an outstanding loan after age 59 ½ will be in the same situation but will not have to pay a 10 percent penalty if they are not able to repay the loan within the time allotted.
Are you getting a break on fees? Some companies, especially large companies, are able to negotiate special fees for the funds available in the plan. These fees would not be available to the public, even on the same funds. If you are taking your money out because you want more variety in your investment options, make sure your company doesn’t offer a brokerage option first. Some retirement plans offer discounted brokerage fees when investing using their work retirement plan. Watch out, though, because there could be trading restrictions imposed that you wouldn’t have to deal with in an individual account.
Is your preferred fund investment open? Fund managers will periodically close a fund to new investors. In some cases, companies negotiate with the fund managers to keep the investment open to its employees through the retirement plan only. If you sell out of your position in your plan and take a distribution on your account, you may not be able to buy back into the fund. If you are happy with a fund’s returns and the level of fees you’re paying, you may want to consider holding your position if the plan will allow you to.
Do you have enough to diversify? In your plan, you don’t have to meet fund minimums to invest. You are grouped with the rest of the employees in the plan and invested as one. If you leave the plan, you’ll need to meet the required minimums for the funds on your own, unless you have the option to roll over to another employer-sponsored plan. If you don’t have enough in your nest egg to diversify across several funds, you’ll want to research options to help you diversify with one fund—like a target-date fund or a risk-based option. Make sure to check out the fees before investing because that will cut into your long-term returns.
Do you even have an option? Some companies have minimum requirements to keep your account in good standing after you leave employment. If you don’t meet the company minimum, you’ll be forced to take a distribution. Contact your retirement plan provider to find out if you meet the requirement of any minimum balance. If you don’t, you’ll have a specified number of days to roll the account over into another qualified option before the provider will take action for you.
The best strategy for all of retirement planning is to know your options ahead of time so you have enough time to plan. This holds true for the distribution process as much as it does for the saving process. Take some time to review the plan-specific rules and contact your provider if you have any questions.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.