The Trick to Managing Your 401(k)
BY ELLEN HOFFMAN

You're getting close to retirement and think you're in pretty good shape: Not only can you count on a modest pension, but also on your 401(k) account, which has been nicked a bit by the recent stock market slide, but is nevertheless sizable. There's only one thing bothering you: You're not sure how best to tap that money. Should you leave it alone? Take it out in installments? Or take it all out in one lump sum-just take the money and run?

Whether you choose one of these or some other course of action, your decision will have major consequences for your retirement. Your nest egg could grow or diminish depending on what you decide. "There are many different options for 401(k) withdrawals," says Scott E. Bordelon, a financial planner in Covington, Louisiana. "Some are irrevocable, and some could have very harmful tax consequences." People don't always choose wisely in tapping their 401(k) money. A recent survey by Hewitt Associates, a consulting firm in Lincolnshire, Illinois, found that of the people who took final withdrawals from 401(k) plans in 2001, 29 percent took a lump-sum payment-a move that could cost them more in taxes than they may have expected.

“We've found that even people who are very good at accumulating money have not thought about how to live out of one sum of money for 30 years”

Yielding to the temptation to take the money and run, experts say, may be the fastest way to run out of money. Instead, they say if you are one of the 11 million Americans 50 and older who plan to rely on savings from a 401(k) or similar plan to finance your retirement, you need to plan now how to make that money stretch as far as possible. "We've found that even people who are very good at accumulating money have not thought about how to live out of one sum of money for 30 years," says Caroline Boyd, senior vice president for strategic marketing for Fidelity Institutional Retirement Services Company.

The withdrawal or "distribution" options your employer offers depend on the rules for your company's plan. Most, however, include some or all of the following:

• leaving the money in the plan,
• cashing out in a lump sum,
• rolling over a lump sum into an IRA,
• converting to an annuity,
• taking the money in installments, or
• using some combination of these.

In deciding on a withdrawal plan, you'll have to weigh such factors as your age, other sources of income, your tax situation, and how comfortable you feel investing and managing your money.

Here are some pros and cons of major 401(k) withdrawal options:

resources

Some useful resources about withdrawing money from your 401(k) when you retire: What You Should Know About Your Pension Rights, U.S. Department of Labor. For a free copy of this pamphlet, call the Department at 800-998-7542 or read it online at: www.dol.gov The American Savings Education Council website at: www.choosetosave.org Taking Money Out, an article at: www.quicken.com/retirement/401k The Complete Idiot's Guide to 401(k) Plans, a book by Wayne G. Bogosian and Dee Lee (Alpha Books, 2002).

-Your company may allow you simply to leave money in the 401(k) plan and withdraw it later. When you turn 70 and a half, however, the IRS requires you to start taking the money out or pay a stiff penalty if you don't.

PRO: This option is most attractive if you don't need the money immediately, says financial planner Bordelon, because it enables you to stay with investments with which you're familiar and comfortable.

CON: The downside is that your investment choices will be limited to those in the plan, and you may miss out on greater flexibility that could be useful later in your retirement.

Brian P. Beck, a financial consultant in Great Neck, New York, also warns that if your employer should go bankrupt, as Enron and other companies have, you could lose some or all of the money or experience a long delay in getting it.

-You can choose to take a "lump-sum distribution" by cashing out your account.

PRO: Cash, of course, is totally liquid and can be put to any use-buying a retirement home, starting a business, investing in education, even going on a spending spree.

CON: Aside from the fact that a cash windfall can burn a hole in your pocket, this strategy is expensive. You'll have to pay income tax on the money you withdraw, and the IRS requires your employer to withhold 20 percent of the lump sum toward that income tax. If you're younger than 59 and a half, you will have to pay an additional 10 percent for "early withdrawal."

-A more economical alternative is to roll over the lump sum into a traditional IRA at a mutual fund company, stock brokerage, bank, credit union, or other financial institution.

PRO: In general, "the great advantage of a rollover is flexibility," says Roger M. Smedley, a financial planner in Salt Lake City, because you can invest IRA money in stocks, bonds, mutual funds, CDs, Treasury notes, and other instruments-and sell them at any time.

CAUTION: To avoid income tax and penalties, the rollover must be completed within 60 days of the withdrawal from your plan.

You will have to pay income tax on the money when you withdraw it from the IRA account. Financial analysts say that before rolling your 401(k) into an IRA, find out about the commissions and fees you'll be charged in the IRA.

-About 30 percent of plans allow you to convert some or all of your 401(k) assets into an annuity that guarantees regular, fixed payments.

PRO: An annuity can provide guaranteed income for the rest of your life and relieve you of the challenge and uncertainty of managing your investments.

CON: Annuities come in many forms, and choosing wisely requires careful study. Some options include whether to receive lifetime payments or payments over a specified number of years, and whether to cover a surviving spouse.

Another possibility: If you don't want to rush into an annuity, you can roll money out of your 401(k) into an IRA and use the IRA funds to purchase an annuity on the open market later. This option may offer a wider choice of annuities than your employer offers.

-Some employers allow you to withdraw a percentage of the assets from your 401(k) in installments, most commonly over five, 10, or 15 years, says Fidelity's Boyd.

"If you've chosen five years, or 60 monthly installments," she explains, "the first payment will be one-sixtieth of the account value, the next payment will be one fifty-ninth and so on." Your 401(k) investments are sold in the order you and the plan administrator agree on ahead of time.

PRO: If you're happy keeping your savings in your employer's plan and want a steady stream of income but don't want to be locked into the rules of an annuity, this approach could be right for you.

CON: You'll have fewer investment choices and less flexibility.

-You can combine options for withdrawing your 401(k) money.

PRO: This approach enables you to tailor a plan most suited to your needs. Although there's no standard formula for how to divide the assets, experts say you should lock in enough guaranteed income (from Social Security and an annuity) to cover essentials such as housing, utilities and medical care. Then if your other investments don't perform up to expectations, the only expenses you'll have to cut will be for nonessentials.

CON: Sorting all this out can be complicated and involves a hefty amount of research, planning, and arranging.

A FINAL CAUTION: No matter how you take your money, don't forget that you must start withdrawing from your 401(k) at 70 and a half.

New IRS rules simplify these "required minimum distributions." But stiff penalties await anyone who fails to follow these rules: You can be fined 50 percent of the amount you were supposed to withdraw but didn't.

"It's not what you don't know that can hurt you," Smedley says. "It's what you don't know that you don't know."

 

 

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