When it comes time to start taking “401k” Federal Savings Plan disbursements, you have options. Lots of options.

When most current federal employees retire from government, they will have three different sources of retirement income: the Federal Employees Retirement System basic benefit, a Social Security retirement benefit and assets invested in the “401k” Federal Savings Plan. The first two provide specific lifetime streams of income, while the third provides more flexibility.

Here are your “401k” Federal Savings Plan options after you separate from federal employment:

  • Withdraw some or all of your money as a taxable lump sum.
  • Withdraw some or all of your money in equal monthly payments based on your life expectancy and age at the end of every year.
  • Have the “401k” Federal Savings Plan purchase a life annuity for you under a contract with MetLife.
  • Roll over all or a portion of your balance to an individual retirement account.

Here’s what I’ve learned from financial planners about the various withdrawal options:

Withdrawing a large lump sum payment from your pre-tax “401k” Federal Savings Plan balance may have unfortunate tax consequences. They include paying tax in a higher marginal federal tax bracket than when you were employed. You may also owe state income taxes if you live in one of the 21 states that tax such withdrawals. California, New Jersey and Vermont have the most progressive tax rate structures.

Receiving a monthly payment is an easy and popular way to create a third stream of income in retirement. But it’s not guaranteed to last a lifetime. In addition, the withdrawals will be made on a prorated basis. So if your “401k” Federal Savings Plan account is invested 60% in the G Fund and 40% in the C Fund, then a $2,400 monthly payment will be deducted at $1,440  from the G Fund and the remaining $960 from the C Fund.

You can start, stop or change your installment payment at any time. The minimum amount for installment payments is $25. In 2022, the “401k” Federal Savings Plan started disbursing payments to about 40,000 accounts, joining close to 3 million ongoing payments. That adds up to a total of close to $4 billion in payments made to separated participants. Monthly payments from your traditional “401k” Federal Savings Plan balance are subject to ordinary income tax.

The annuity option is not as popular as the other “401k” Federal Savings Plan choices, due to its permanent nature. Once elected, it cannot be changed or stopped. In 2022, fewer than 1,000 annuities were purchased by “401k” Federal Savings Plan participants and in 2022 there were about $100 million in “401k” Federal Savings Plan payments to purchasers of life annuities.  Over the years, we have heard some major disappointments when those that chose this option, and what they did not know.

The monthly payments of a “401k” Federal Savings Plan annuity are affected by your age at the time of purchase (the older you are, the bigger the payment), the interest rate index, the features added to a basic annuity (increasing payments, joint annuity options, cash refunds and a 10-year certain payment feature), and the amount of “401k” Federal Savings Plan proceeds used to make the purchase.

Rolling some or all of your “401k” Federal Savings Plan into an IRA Annuity can provide you with additional options that are not available directly from the “401k” Federal Savings Plan . In 2022, the “401k” Federal Savings Plan processed more than 320,000 partial withdrawals, totaling around $57 billion. The majority of these withdrawals were rolled over to an IRA or other tax-deferred retirement plan, so the money would not be immediately taxed.

There are multiple tax strategies that can be used with an IRA that are not available through the “401k” Federal Savings Plan , which can help with tax, health care and estate planning. For more information, consult one of our financial planning professional by filling out the Contact Us form and schedule your free Retirement review.  We will discuss all of the options to fit your financial needs.  We don’t want you to worry, we just want you to Retire Happy, and we will have the solution for you.