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If I retire in '14 at age 55 and roll the lump sum pension into my 401k will I need to pay 10% penalty on withdrawals?

401k is with current employer

Sep 17, 2013 by Bob from Batavia, IL in  |  Flag
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9 votes

Hi Bob, Good question! Perhaps you've picked up on a rule that gives you a way around the normal 10% penalty that typically applies when you make withdrawals prior to age 59-1/2. If you make your transaction as you've indicated: 1) roll over lump sum to 401(k), 2) retire and LEAVE 401(k) where it is with current employer, and 3) take a withdrawal from your 401(k), you will avoid the 10% penalty. The reason is because there is an exemption from penalty between the ages of 55 - 59.5 when you take a withdrawal from a former employer's retirement plan.

The caution I'd make is this: if you intend to make these penalty-free withdrawals prior to age 59-1/2, DON'T roll the money over to an IRA. If you do, you will lose that penalty-free exemption. Now, others may tell you there's a way you could deal with that issue too, and there is - it's called a Section 72(t) withdrawal - but it's complicated and has some risks. Best option: keep the money where it is, or decide what amount you will need for withdrawals prior to age 59-1/2, and leave that amount in the 401(k); rollover any excess balance if your plan allows and if that's important to you.

Michelle Ash http://www.wealthguards.com

Comment   |  Flag   |  Sep 17, 2013 from Jacksonville, FL

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8 votes

As long as the lump sum is rolled directly into the 401k via direct transfer to the plan or you send in a rollover check yourself within 60 days, you would not have to pay the 10% penalty for pre 59 1/2 withdrawals. However, you need to make sure of two things before you do this. First, does your 401k accept outside rollovers (unless you are actually referring to your own personal IRA that you opened, which then would be fine) and Second, you must make sure that your pension lump sum is what is called qualified money in order to roll over that amount. I hope that helps.

2 Comments   |  Flag   |  Sep 17, 2013 from Malvern, PA
David P. White

I believe you are commenting on the 20% mandatory tax withholding that occurs if the 401k balance is distributed directly to the participant instead of rolled over to an IRA. Bob’s question relates to the 10% federal tax penalty on withdrawals from the IRA Rollover prior to age 59.5. Thanks for clarifying in your follow-up.

Flag |  Sep 17, 2013 near San Diego, CA
David A. Kring, CFP®

No, I was referring to the penalty for early withdrawal, but I think Michelle may be onto what his question was really aimed at; not always easy to tell from the question

Flag |  Sep 17, 2013 near Malvern, PA

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8 votes

Hello Bob,

The law allows you to make withdrawals from a 401k account, without paying the 10% early withdrawal penalty, as long as you are no longer employed by that company. Since true lump sum pension money is generally "qualified" or pre-tax money, these dollars can usually be rolled into a qualified retirement plan such as a 401k, as long as the plan accepts rollovers. Checking your Summary Plan Description documents will verify your plan features; you can usually find this on your plan's website. If not, request it from HR.

If, however, you roll money from a lump sum pension payout, or from a 401k, into an IRA account - then you lose this early withdrawal feature. Since withdrawals from IRA's prior to age 59 and 1/2 typically cause a 10% penalty, this is one of the few times it makes sense to keep your money in a 401k after you've retired. You might consider leaving only the amount that you expect to need over the next 5 years in your 401k, so you can use those dollars for your income needs - and roll the remainder of the balance into an IRA where your investment options are unlimited, and your investment expenses are often (but not always) lower.

Jon Castle http://www.Wealthguards.com

Comment   |  Flag   |  Sep 17, 2013 from Jacksonville, FL

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5 votes

let me also clarify, that you are just referring to only getting penalized on the rollover to the 401k and are not planning on withdrawing the money right after you do that.

Comment   |  Flag   |  Sep 17, 2013 from Malvern, PA

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1 vote

Bob, if you do it as you say, roll pension into 401(k) then retire – be sure employment is terminated, you would not have a 10% penalty; there would be 20% withholding, but you will either owe it partially or in full anyway.

But here’s another thought. Keep only what you think you will need for the next 5 years of distribution in the 401(k) – keep it over $5000 or they can force a distribution. That may mean you can roll the lump sum pension into an IRA. You may also do a partial 401(k) rollover into an IRA, if allowed. This will give you some control over fees and investment choices.

Comment   |  Flag   |  Sep 19, 2013 from Delray Beach, FL

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