The rules about withdrawing from a 401(k) plan seem fairly straightforward.
You need to wait until age 59½ and retirement before taking money out. Otherwise, you get hit with penalties. Simple, right?
Actually, the rules surrounding 401(k) account withdrawals -- or distributions as the IRS likes to call them -- are not quite as simple as you think.
Consider these two reader questions received recently.
Q: If I am currently active in a 401(k) at my employer but have another 401(k) being held by an "ex-employer," would I be able to withdraw funds from the (former employer's) 401(k) without penalty -- assuming, of course, I am over 59½? -- R.M., Los Angeles
Q: My husband is 62 and is looking to retire in the next five years. He has a matching (up to 8 percent) 401(k). At present the 401(k) is 60 percent stocks, 40 percent bonds. Should we move the 401(k) to an IRA now? We would continue contributing to the 401(k) until he retires, due to the match, but we are uncomfortable leaving the bulk of our money where it is. -- L.L, Westbrook, Maine
Let's start with the first question.
R.M., the answer is, yes. If you are at least 59½, you can contribute to your current employer's 401(k) plan and at the same time withdraw funds from the second 401(k) account held in your former employer's plan.
In general, once you have left a company, there are few, if any, restrictions on what you can do with money you have accumulated in their 401(k) plan. In most cases, you can take it out, keep it there or roll it over to another 401(k), an IRA or some other retirement plan.
Withdrawals can be taken even if you've moved on to another company, and you're contributing to its 401(k) plan. What happens with one 401(k) account has little to do with the other.
The key issue is whether you will be subject to an early withdrawal penalty. If you're over 59½, there are none under any circumstances. In some cases, you might be able to withdraw penalty free if you're as young as 55 -- or even 50.
Switching to an IRA
For more details on retirement plan withdrawal rules, consult IRS Publication 575 "Pension and Annuity Income."
In your case, R.M., I would just think through what if any benefits there are to withdraw from one 401(k) account and then contribute to another.
It may be a good idea, particularly if you are contributing to the current employer's plan to capture a match offered by the company. However, the tax savings of contributing to the current plan could be negated by withdrawals from the old plan. Also, be careful about allowing the withdrawals from the old plan to push you into a higher tax bracket when combined with your employment income.
Again, I'm not saying don't do it. Just be sure to think through the implications of taking out on one side and contributing on the other.
Now, let's turn to the second question about moving money out of a 401(k) into an IRA.
L.L., I can't say for certain this is the right move for you and your husband. I just don't know enough about your situation to say. However, it's definitely a move worth considering.
First off, let me explain that just such a move is allowed by many 401(k) plans through what is known as an "in-service rollover." Even though L.L.'s husband remains employed by the sponsor of his 401(k) plan, many plans allow employees who have reached age 59½ to remove all or a portion of their assets from a 401(k) plan. They can either do an outright withdrawal and pay the tax, or as is under consideration here, roll over the assets into an IRA.
Be aware, L.L., that your husband will need to check the details of his particular 401(k) plan to see if such a move is allowed. IRS regulations allow employers to offer in-service rollovers, but they do not mandate they be offered. It could be allowed outright, allowed under limited circumstances or not allowed at all.
The advantages of rolling over 401(k) funds into an IRA can include lower fund expenses, better investment selection and diversification away from a 401(k) plan heavy on company stock.
Tax Consequences for IRA Switch?
But there can be some disadvantages as well. These include the loss of a 401(k) loan option and, in some states, reduced creditor protection against lawsuits and bankruptcy.
Also, if you are moving company stock out of a 401(k) plan, be careful to review a tax benefit known as "net unrealized appreciation" or NUA. If the company stock has risen in value considerably, you want to be sure you handle this move correctly to reap big tax savings.
If a financial adviser is encouraging you to roll over 401(k) funds into an IRA, be aware of his or her motive. If the advisor is going to manage those assets for you, then he or she has the potential to earn higher fees than if the assets remained in the 401(k).
There may be a sound reason to transfer assets to an IRA; just keep in mind the adviser's interests.
Finally, L.L., I would urge you to think about why you want to move the money to an IRA.
If you think holding the money in an IRA as opposed to a 401(k) will protect you against market downturns, think again. The level of risk in your husband's portfolio hinges on investments he owns, not the type of account.
IRAs and 401(k) plans are merely holding bins. It's what you store in those bins that dictate your investment risk.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at firstname.lastname@example.org.