Economic uncertainty is causing some companies to revisit and adjust their balance sheets. Cutting expenses may involve layoffs or early retirement packages for current employees. If you find yourself in the situation where you are presented with an early retirement package, there are many things to consider before accepting the offer. These considerations will vary based on the offer presented to you and should be weighed carefully from a cash flow and tax liability perspective. Your financial plan should be built for your unique situation, so there is no “one size fits all” approach to analyzing the deal. However, in almost every case, you will be faced with the decision of what to do with your retirement plan at work.
To start, some basics. Distributions from 401(k) plans and most other employer-sponsored retirement plans are taxed as ordinary income, and if you take a distribution before age 59 ½, a 10% federal income tax penalty commonly applies. Generally, once you reach age 72, you must begin taking required minimum distributions from retirement accounts because the IRS wants their tax dollars ASAP. Here is a fun fact…..although Roth IRAs don’t require you to take minimum distributions at age 72, Roth 401(k) Plans do. Therefore, the advantage of rolling over your Roth portion of the 401(k) avoids any required distributions.
To avoid being immediately taxed and potentially penalized on the distribution from your company sponsored retirement plan, a direct rollover (also known as a “trustee-to-trustee transfer”) to an IRA (Individual Retirement Account) would be the way to go. Rollovers allow you to postpone the taxes, avoid the penalty and, oftentimes, provide a wider range of investment options than many employer-sponsored retirement plans.
Now, the fine print. There are circumstances where those under age 59 ½ could access money in a retirement plan while avoiding the early withdrawal penalty. The CARES Act passed earlier this year in response to the pandemic provides a solution for this. The CARES Act gives you extraordinary flexibility. You can choose to spread the taxed owed over three years, or pay it all in 2020. In addition, it gives you up to three years to redeposit the withdrawn money into the retirement account. You will want to involve you tax advisor during this process to make sure you are documenting everything properly. While we typically don’t recommend tapping into an account that was earmarked for retirement for something other than retirement, unusual circumstances happen and this may be the only viable option. There are strategies that you can implement to make sure you keep as much of your hard-earned money as possible.
Weigh the pros and cons. There are typically more investment options available in an IRA than those available in a company sponsored retirement plan. This allows you to customize an asset allocation that is appropriate for your risk tolerance, return objectives and timeframe. Expenses for these investment options also differ. In an IRA, you may be able to implement an investment strategy that costs less than the same investment strategy in a company 401(k).
If you are faced with an early retirement offer or layoff and you have questions, please feel free to give us a call so we can review the details with you.