Chapters

00:00 Introduction to 401k Options for Mississippi PERS Members at Retirement

00:38 Mississippi PERS Retiree 401(k) Participation and Balance Estimates

01:45 4 Major Options of What to do With 401(k) at Retirement

02:45 Leave Money in Previous Employer 401(k) Plan

04:25 Take Distributions from 401(k) Account

06:01 Rollover 401(k) Balance to Another Qualified Plan or IRA

07:22 Purchase Service Credit Using Funds in 401(k)

09:05 Case Study 1: Leave Money in 401(k)

10:45 Case Study 2: Take Distributions from 401(k)

12:42 Case Study 3: Rollover Inherited 401(k) to Traditional IRA & Roth IRA

14:28 Case Study 4: Transfer 401(k) to Purchase Service Credit

17:07 Action Items for PERS Members With 401(k) Approaching Retirement

17:54 Preview of Next Video and Calls to Action

19:07 Legal Disclaimer

Transcript

Hi everyone, I'm Ryan Earley, vested PERS member, former Public School Finance Officer, Current Financial Planner, and host of the PERS Pro YouTube channel. Today, we are breaking down the four major options a PERS retiree has with their or their spouse's 401k plan, the pros and cons of each option, the taxes and penalties associated with each option, and we'll end our discussion with four PERS retirement case studies to tie everything together. Let's get started.

The choice of what to do with a 401k plan balance impacts a large portion of the Mississippi public employees' retirement system population. Unlike specialized public government plans like 457b, 403b, or 401a, a 401k is the standard employer-sponsored retirement plan offered by most companies. Chances are either you or your spouse has a 401k account with money in it at retirement. The following table outlines my estimates.

For Mississippi PERS households based on publicly available PERS, US Census, and 401k custodian data. I estimate up to 20% of PERS members retire with a legacy 401k from a past job they had working for a company, and up to 40% of PERS retirees have a spouse that has a 401k. The estimated balances in these 401k accounts range from $30,000 to $60,000 for a PERS retiree and $100,000 to $200,000 for a PERS retiree spouse. Since these are averages, there will be many of you with balances greater or less than these averages. 

So what are your options at retirement with your 401k? I break these options down into four groups, building directly on our analysis of 457b, 403b, and 401a plans from our previous videos, videos number 61, 62, and 63.

You can leave money in the plan and keep your retirement funds exactly where they are with your previous employer's corporate plan sponsor. You can take withdrawals or distributions and draw down cash systematically or ad hoc to supplement your fixed PERS pension income. You can roll over the balance and transfer your 401k entirely out of the old plan and into an outside qualified account or RIA. And you can purchase service credit by moving pre-tax funds directly to the Mississippi PERS system via a transfer to buy extra years of service to permanently boost your lifetime pension income. 

Let's unpack the rules, pros and cons, and tax implications of each option. 

Let's begin by looking closely at option one: keeping your 401k funds inside your previous employer's corporate plan.  Reviewing the plan rules, you can generally leave your money in a corporate 401k indefinitely after separating from service, provided the plan allows it. Both pre-tax and after-tax balances are subject to IRS required minimum distributions or RMDs once you reach age 73, but any designated Roth 401k balances are exempt from these RMD rules. 

Looking at the pros and cons, leaving the money in plan grants you institutional fee pricing on index funds in most large 401k plans and preserves the workplace age 55 separation rule for penalty-free access before the age of 59 and a half. On the downside, you are trapped in an inflexible investment menu, and maintaining multiple legacy retirement accounts can complicate tax planning, estate planning, and portfolio management. 

Looking at taxes and penalties, the IRS permits 100% tax-deferred growth on pre-tax accounts, 100% tax-free growth on Roth accounts, and 100% tax-deferred growth on after-tax earnings for money left in a 401k at retirement. Pre-tax distributions are taxed as ordinary income when withdrawn, and also may face a 10% penalty if withdrawn before age 59.5, unless an exemption like the rule of 55 applies. At the state level, Mississippi does not tax internal growth within a 401k and qualified retirement distributions remain free from state income tax as well. 

Next, let's explore option two: taking distributions from your 401k to supplement your retirement income. Looking at the plan rules, your 401k corporate plan documentation will dictate your distribution options. Most plans allow you to execute a single lump sum cash out, set up systematic monthly or quarterly automated payouts, or pull periodic cash as needed.

Looking at the pros and cons, one major pro is taking distributions gives you the ability to customize your cash flow. However, taking distributions halts the power of tax-deferred and tax-free compounding growth, and large, unmanaged pre-tax withdrawals can spike your taxable income, pushing you into higher marginal federal income tax rates in the years of withdrawal. This can have cascading effects on your Medicare premiums, Social Security benefits and eligibility for certain federal income tax deductions and credits.

Looking at taxes and penalties, every dollar of pre-tax distribution is treated by the IRS as ordinary income and may also be subject to the 10% early withdrawal penalty if taken before age 59 and a half, unless an exception like the Rule 55 applies. Withdrawals of after-tax principal are tax-free, while after-tax earnings are taxed as ordinary income. In Mississippi, qualified retirement income from recognized plans is fully exempt from state income tax, but premature, non-qualified distributions failing to meet plan retirement requirements can be subject to Mississippi State income taxes. 

Let's explore option three, executing a 401k account rollover to another qualified account or IRA.  Looking at the rules, you are legally entitled to move your 401k balance via a plan-to-plan transfer if you take another job or via a qualified rollover to an IRA. Pre-tax funds slide seamlessly into a traditional IRA or new workplace plan, while Roth 401k balances can be directed straight to a retail Roth IRA. 

Looking at the pros and cons, the pros of a rollover include unlimited investment freedom across individual stocks and ETFs alongside centralized account management under a single custodian. However, the primary con is the permanent forfeiture of the workplace age 55 separation rule, meaning any withdrawals prior to age 59 and a half will incur a 10% early withdrawal penalty unless another exception applies. 

Looking at taxes and penalties, direct like-to-like custodian rollovers are 100% tax-free at the federal level, whereas executing a conversion from pre-tax 401k to a Roth IRA triggers immediate federal ordinary income taxes as a Roth conversion. Mississippi Tax Code mirrors the federal code by treating direct transfers as non-taxable events, and future qualified IRA retirement distributions remain completely exempt from Mississippi State income tax. 

Finally, let's look at option four: utilizing your 401k account to purchase service credit directly from PERS. IRS sections 401k and 414d legally permit you to execute a direct trustee-to-trustee transfer from a qualified retirement plan to a governmental defined benefit plan like PERS. This allows you to purchase eligible service credit, such as out-of-state public service or military time, which we outlined back in video number 31. Crucial spousal rule note here: Only a 401k account belonging directly to the PERS member can be utilized to purchase service credit. A spouse's corporate 401k balance cannot be used to buy service credit for the PERS covered member unless under certain circumstances the member is a surviving spouse. 

Looking at the pros and cons, the pros of purchasing service credit include increasing your lifetime guaranteed inflation protected pension and triggering COLA sooner. However, the primary con is that the funds used to buy the service credit can never be accessed again if you are ever short on cash. 

Looking at taxes and penalties at the federal level, a direct trustee-to-trustee transfer of pre-tax 401k dollars to PERS is a 100% tax-free event that completely waives early withdrawal penalties. The Roth and after-tax balances generally cannot be transferred to PERS. When you begin receiving the increased pension income, that increased income will be subject to ordinary federal income taxes, just as any other PERS pension income. At the state level, the initial service credit purchase transaction triggers zero Mississippi income taxes or penalties, and the permanently elevated lifetime pension payments remain 100% exempt from Mississippi State income tax. 

To tie everything together, let's look at our first retirement case study to see how these rules apply to a PERS retiree with a legacy 401k returning to PERS agency on a part-time basis. 

In our first scenario, Mark is a 54-year-old single professional who has officially retired and begun drawing a $42,000 annual pension from PERS. Mark also holds a legacy corporate pre-tax 401k with a $90,000 balance from an earlier private sector five-year career. He elects to transition into a part-time role under PERS return to work rules and leaves his old corporate 401k investment portfolio exactly where it is since it is the only non-PERS retirement asset he has. He strategically coordinates his part-time hours to qualify for health coverage under the Active State and School Employees Life and Health Insurance Plan.

What are the tax implications? Leaving his funds inside his legacy 401k plan protects Mark from immediate taxes, keeping his $90,000 balance 100% tax deferred at both the federal and state levels. His active part-time earnings are taxed at ordinary federal and state marginal rates, but because he is only 54, any premature 401k withdrawal prior to age 59 and a half would trigger a 10% IRS penalty along with potential state income taxes.

What are the federal benefit implications? Mark has zero interaction with the ACA marketplace and the premium tax credits because he is on the active state employer sponsored group health plan. At age 54, Mark is far too young for Medicare ERMRA lookbacks or Social Security Earning Limit or Benefit Taxation concerns. 

Let's examine case study number two, focusing on systematic distributions from a 401k during an early retirement.

In our second case study, Susan is a 62-year-old PERS retiree married to a corporate accountant. Their household income before retirement was $190,000. In retirement, their current baseline household modified adjusted gross income sits at $72,000. To build a supplemental income bridge alongside her new PERS pension, Susan sets up automatic, systematic distributions to pull exactly $1,000 a month or $12,000 a year out of her husband's pre-tax corporate $401K.

What are the tax implications? Because Susan's husband is 62, he has safely bypassed the IRS age 59 and a half barrier, meaning his $12,000 annual stream is entirely exempt from the early withdrawal penalty. The distributions are taxed as ordinary income by the IRS, but here in Mississippi, as residents, the entire $12,000 annual distribution from the 401k is 100% exempt from state income tax. 

What are the federal benefit implications?  Susan and her husband face a major early retirement health care challenge. Adding a $12,000 distribution raises their household modified adjusted gross income from $72,000 to $84,000, which directly reduces their monthly ACA premium tax credit and increases their out-of-pocket health insurance premiums. 

On the bright side, their income remains well below the Medicare IRMAA threshold of over $200,000 for a married couple.  So it is unlikely these distributions will increase their Medicare premiums in the future. These distributions will not trigger the Social Security earnings test because they are considered passive income. Susan and her husband's Social Security benefits will be subject to federal income taxes, and depending on their social security benefit amount, the distributions from the 401k could cause more of their Social Security benefits to be subject to federal income taxes when they begin taking Social Security.

Next is case study number three, evaluating a direct rollover of a 401k account with mixed tax treatment inside of it. 

Linda, a 58-year-old widowed PERS retiree, has a baseline income of $48,000 in retirement. Linda holds a $150,000 balance split across pre-tax and designated Roth components within her husband's inherited 401k wanting to break free from her husband's old employer's restricted menu as a small business. She authorizes a direct custodian-to-custodian rollover, moving $100,000 of pre-tax funds into her own traditional IRA and $50,000 of Roth funds straight into her own Roth IRA. She does this since she does not need the money before age 59 and a half. 

What are the tax implications? Because Linda executed a direct like-to-like custodian transfer from her husband's inherited pre-tax and Roth components to respective IRAs, the entire transaction is 100% tax-free and penalty-free at both the federal and state levels. However, by moving the pre-tax inherited 401k to a traditional IRA, she permanently surrenders any workplace age 55 rule penalty exemption on those assets. The upside though is that the RMDs are now based on Linda's age rather than her husband's age, who was five years older than her. 

What are the federal benefit implications? Linda navigates her early retirement health care via the ACA marketplace. Because a direct custodian rollover is a non-taxable event, the $150,000 transaction does not impact her modified adjusted gross income in retirement. Her optimized marketplace health insurance subsidies remain completely intact, and this rollover generates zero immediate IRMAA premium surcharges or Social Security survivor benefit concerns. 

Our final example, case study number four, showcases a veteran who transitioned from the private industry to PERS while taking military leave of absence and ultimately retired from PERS and chose to buy service credit for his non-active duty assignment. 

James is a 63-year-old married retiree who began his career in private sector before entering Mississippi Public Service and taking several leave of absences while in the National Guard during his public career. James contributed on a pre-tax basis to a corporate 401k early in his career, which has grown to $145,000.  His income before retirement is $135,000, and he is projected to have a baseline retirement income of $52,000. He is retiring from PERS based on age rather than service. 

While PERS grants up to four years of active duty military service credit at no cost to eligible vested members who return directly to public service, James did not fit those specific zero cost criteria due to his service being non-active duty. To maximize his pension, James decides to execute a direct trustee-to-trustee transfer of $145,000 from his legacy pre-tax 401k to PERS to purchase the maximum allowed five years of service credit for his qualifying non-active duty military time. 

What are the tax implications? Moving pre-tax assets directly from a private 401k to a governmental defined benefit plan like PERS to purchase allowable service credit is a 100% tax-free transaction at the federal level. Because James is 63, he has already bypassed the standard early withdrawal penalty window as well.  Looking ahead, the elevated lifetime monthly pension checks he draws from PERS will be subject to normal federal ordinary income tax, but the entire pension remains 100% exempt from Mississippi State income tax. 

What are the federal benefit implications? Because a direct trustee-to-trustee transfer is completely non-taxable, the transaction does not increase James's adjusted gross income. His household avoids any negative shocks with early retirement health insurance adjustments since he is enrolled in the state health and life insurance plan as a retiree rather than the ACA marketplace. 

James also will avoid Medicare IRMAA surcharges starting at age 65 when he enrolls in Medicare, since his retirement income will be well below the Medicare threshold for married couples. Finally, the resulting incremental pension increase represents passive retirement income, meaning it will have zero impact on the Social Security earnings test if James chooses to draw early retirement benefits before his full retirement age and remain working.  However, the increased retirement income will increase the percentage of his Social Security earnings that are subject to federal income taxes. 

If you or your spouse have a 401k account balance from a prior corporate employer, here are your action items for today. One, log into your accounts, go to your specific corporate participant portals, and verify your exact current balances across pre-tax, after tax, and designated Roth accounts. Two, request the summary plan document.  Contact your corporate plan record keeper and request the official plan rules detailing your distribution options, fees, and whether they recognize the age 55 separation rule allowing distributions to begin before age 59 and a half. Three, audit your eligible service credits. Work directly with a Mississippi PERS benefit analyst to get an official cost calculation for any out of state service or military buybacks you are eligible to buy.

I hope this video helps PERS members confidently navigate their choices regarding their or their spouse's corporate 401k plans as they approach retirement. In our next video, we will continue down this supplemental retirement path and answer a closely related question: What should a PERS retiree do with their traditional IRA? 

Please make sure you subscribe so you don't miss this and other videos in our new retirement series. If you found this video helpful, you can thank me by hitting the thumbs up button and sharing it with other PERS members.

If you have a follow-up question about PERS or anything else related to personal finance, please visit our website at perspro.ms click YouTube, and submit your question or topic for a future episode. 

And finally, if you're looking for a financial planner who specializes in helping PERS members plan for retirement, including deciding what to do with balances in a 401k plan, please visit our website at perspro.ms to learn more about our firm and to see if we are a good fit for you. 

Thank you for your valuable public service to the state of Mississippi.

We'll see you next time.

Disclaimer, this video is for educational and informational purposes only. Neither the host nor this YouTube channel are officially affiliated with, endorsed by, or sponsored by the Public Employees Retirement System in Mississippi. Always consult a qualified professional for personal advice specific to your situation.