As financial advisors, our job is to help clients create wealth. Most people expect us to accomplish this through market investments. Although that does play an important role, advice regarding financial decisions outside of the market can often amount to significant savings and wealth creation. The topic covered here is one that has amounted to significant savings for many of our clients. If you are currently retired or are approaching retirement and have a 401(k), this article is for you.
When talking about financial planning, there are two main phases of life: the accumulation phase (pre-retirement) and the distribution phase (post-retirement). The 401(k) is a fantastic savings vehicle for those in the accumulation phase. If you are currently working, a 401(k) is great! Employers often contribute to this type of account by way of a company match or profit-sharing because the 401(k) annual contribution limit is higher than that of other retirement accounts. Plus, paycheck deductions make saving easy.
If you are already retired, a 401(k) has some weaknesses that you should be aware of. The cost associated with these may be a lot more than you realize.
• When you take a distribution from a 401(k), you do not have the ability to choose which assets you sell. A distribution will require selling from all investments equally. This is a huge disadvantage as you may be forced to sell from the wrong investment at the wrong time. Proper distribution planning requires one to analyze the individual investments and sell those that make sense based on current market conditions and performance expectations. Unfortunately, the 401(k) does not give you this ability.
• If you have Roth 401(k) contributions, you will be forced to take a distribution at age 70.5. This can have large negative consequences to both future tax-free earnings and your ability to pass on wealth tax free. Roth IRA accounts will not force a distribution regardless of age.
• If you are over age 70.5 and donate to 501(c)(3) organizations, you cannot take advantage of a great tax-savings strategy called a Qualified Charitable Distribution (QCD). The tax savings from QCD’s can be thousands of dollars every year. Examples of qualified organizations are churches, universities, humane societies, hospitals, etc.
In many cases, we recommend that clients roll their 401(k)’s into IRA’s at retirement. An IRA is a much better retirement distribution vehicle given its flexibility and its greater selection of investment options. It also does not suffer from the weaknesses mentioned above. 401(k) rollovers are tax-free and easy.
We work hard to ensure our clients make good financial decisions. Often, small changes have a large impact. We have seen investors greatly benefit from a 401(k) rollover. If you have a 401(k) that you can’t contribute to due to separation of service or retirement, we highly recommend you meet with us to discuss if a rollover is in your best interest.