Think you know your 401k? Here are 5 rules a lot of people may not know about…

1.  The Age 55 Rule

Thinking of retiring before 59 1/2 and don’t want to pay a 10% penalty for early withdrawals?

The age 55 rule allows you to take penalty free withdrawals from your employer sponsored retirement plan, like a 401k, before you turn 59 1/2. The rule states that you need to separate service on or after your 55th birthday to qualify. Leaving your company at 53 and waiting until you turn 55 to take distributions won’t work. You need to separate service after your 55th birthday.

This rule only applies to money in your employer sponsored retirement plan. If you roll it to an IRA you lose the ability to do this. It only applies to your employer sponsored plan.  Also, you should remember that the distributions would still be subject to federal income taxes

2.  Employer Stock In Your 401k

If you have employer stock inside your 401k plan, you may qualify for some very special tax treatment if you want to take that stock out.

It’s called Net Unrealized Appreciation or NUA for short and this may be a strategy to consider if you have highly appreciated company stock inside your 401k.

Here’s how it works…
You take an in kind distribution of your company stock, removing it from your 401k. At the time of the distribution you pay ordinary income taxes on just the amount of your cost basis.

So lets say you been buying your company’s stock inside your 401k, and over the years your cost to buy the stock adds up to $25,000. Now that stock is worth $100,000.

At the time of your distribution you only pay taxes on your original $25,000 cost basis at your ordinary income tax rate. The remaining $75,000 is then classified as Net Unrealized Appreciation, and you or your heirs will pay taxes on that whenever the stock is sold.

There are 2 potential advantages of this.
First, as long as the stock has been held for at least 12 months, it will qualify for long term capital gains tax treatment (LTCG). Currently for most individuals the maximum LTCG tax is 15%. (Individuals in the highest tax bracket pay 20%). Compared to the ordinary income tax rate of up to 39.6% that would normally apply to traditional retirement plan distributions.

Second, because the stock is no longer part of your retirement account, it will not be subject to mandatory required minimum distributions. You can keep the stock as long as you want and continue to defer the gains.

3.  Roth 401k Option

The Traditional 401k was the original contribution option. Over the past several years, most 401k plans now offer a Roth 401k option as well. In my experience, I don’t really see a lot of people taking advantage of this. I guess most people want the tax deduction now.

As a quick refresher, with a traditional retirement account, contributions go in before they are taxed, and then you pay tax when you withdrawal the money. With a Roth contribution, you pay taxes on the money before it gets invested, and then withdrawal the money tax free as long as it is “qualified”. 1

Most people probably have most of their money in traditional retirement accounts, however I think a Roth it might make sense for some people. Having the Roth option creates what I like to refer to as tax diversification. In retirement you now have some choices. Take a withdrawal from your traditional account and pay taxes, or take a withdrawal from your Roth and pay no tax. This flexibility can potentially keep you from bumping up into a higher tax bracket, or getting hit with one of the stealth taxes like higher Medicare Premiums.

4.  You Don’t Have To Rollover Your 401k Plan When You Retire

I don’t think in all of my time 20+ years I’ve ever come across a 401k plan that forced somebody to move their 401k plan when they retire or separate service. If you like your 401k plan, you can simply leave it there, or, at least not feel rushed to have to move it.

The only time I have ever seen a case when someone is forced out of a 401k plan is when you have a very small balance and you don’t roll it over. Sometimes they will just issue you a check and close out the account. By small, I’m talking about a balance that’s under $5000.

5. Outstanding Loan When You Retire Or Separate

If you have an outstanding loan on your 401k when you retire or separate service, most of the time the plan provider will require that the loan is paid in full within 60 days. If its not, then the outstanding balance of the loan will become a taxable event. If your under 55, it may also be subject to a 10% penalty as well.

Check with your 401k provider on this. Sometimes they may let you continue making payments on the loan.


This information is not intended to be a substitute for specific, individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

1 Withdrawals from Roth IRA’s prior to age 59 1/2 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.  Future tax laws can change at any time and may impact the benefits of Roth IRA’s.  Their treatment may change.

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