Older Than 55 And Younger Than 59½? Be Careful Rolling Over That 401k

Risk Relativity
June 28, 2017
What is an Index?
July 19, 2017

We’ve seen it too many times. A retiree under the age of 59½ equipped with a traditional IRA balance that is bursting at the seams and a question: “How do I take distributions from my account without getting penalized?”

Well, we can get assets out of an IRA prior to 59½, but the common method – often referred to as 72t distributions – comes with some onerous baggage.

Due to the annual contribution limits applied to traditional IRAs, it is rare that we see really large balances accumulated through annual IRA contributions. In many cases, a large IRA account balance is the result of a rollover from a 401k.

It is a fact that is not widely enough known, but, under the right conditions, distributions can be taken from a 401k prior to 59½ without having to establish substantially equal periodic payments (72t distributions). The conditions that concern us for our present purposes are those in which an individual has a 401k through their employer and retires in or after the year they turn age 55. Under these conditions, distributions can be made from the retiree’s 401k account without having to incur the typical 10% premature distribution penalty.

I’ll say that again. If someone retires from their employer in or after the calendar year in which they turn age 55, they can take distributions from the 401k that they established while employed by their most recent employer without having to pay the typical pre-59½ premature distribution penalty, and without having to establish substantially equal periodic payments.

But this is only true if the distributions are being made from assets held in the retiree’s most recent employer’s 401k plan. Once these assets are rolled into an IRA, this benefit of 401k saving goes away and IRA rules prevail.

As I mentioned earlier, without the ability to make post-55-retirement-distributions from a 401k, many are left with the prospect of establishing substantially equal periodic payments (72t distributions).

What’s the big deal, distributions are distributions, right?

Sure, but substantially equal periodic payments can get tricky from a financial planning perspective. For starters, an account owner has little control over the amount of the distributions because they have to be calculated in one of three ways prescribed by the IRS. Once distributions begin, they must continue according the same method of calculation for the longer of five years or until the account owner reaches age 59½. In theory this doesn’t sound awful, but, in practice, such rigidity can pose some real hurdles that can ultimately disrupt a financial plan.

On the other hand, post-age-55-distributions from a 401k – depending on the plan and custodian – can be much more flexible and customized to a retiree’s income needs and overall retirement plan.

This is not to say that 401k assets should always be left in a former employer’s plan, but everyone should definitely consider all of the pros and cons of moving an old 401k within the context of their personal circumstances before making that choice.

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