WHAT TO DO WITH AFTER TAX 401(K) DISTRIBUTIONS? (FINANCIAL FOCUS)

This "Financial Focus" column is prepared by Edward Jones Investments, headquartered in St. Louis. Jones includes branches throughout the nation, including Cape Girardeau and Jackson.

A 401 (k) plan is great -- but you have to be careful when it's time to withdraw the money.

Of course, how much you have available to take out depends on how much you've put in over the years. It's generally a smart move to contribute the maximum amount possible in your 401(k). For one thing, your money grows on a tax-deferred basis, which means it will accumulate faster than if it were placed in a similar yielding investment on which you paid taxes every year. And, if you're lucky, your employer will match a percentage of the money you invest.

Furthermore, most of your contributions are likely made with pretax dollars -- and these pretax contributions will lower annual taxable income.

Now, let's fast-forward to the day when you leave your current employer. What should you do with your 401(k)? If you've accepted another job, you may be able to roll the money over to your new employer's 401(k) or to an IRA. If you're retiring, you also can roll your 401(k) funds over to an IRA.

But here's the "catch": You can roll over only your pretax contributions to the IRA. If you've made any after-tax contributions, as many people do, this money cannot be rolled over, and you'll have to take it as a cash distribution.

When you accept this distribution, you'll have two key issues to consider. First, there are the taxes. You've already paid taxes on your original contributions, so you don't have to worry about that. But these contributions generated earnings, which have been tax-deferred -- until now. You may want to consider rolling those earnings into an IRA to avoid the taxes and possible penalty.

The second after-tax distribution issue is quite basic: What will you do with the money? If you're going to use the funds as a source of current income, here are two possibilities:

* Set up a systematic withdrawal plan from a mutual fund -- You may want to put your after-tax distribution money into a mutual fund, then withdraw a fixed percentage such as 5 percent or 6 percent -- each year. By choosing a fund that has the potential to earn a higher return than the withdrawal rate, you can protect your principal. A good growth-and-income fund may be an option. This type of fund carries less investment risk than a straight growth fund, but still offers the potential for a competitive return.

* Purchase an annuity and immediately "annualize" the money -- You could use your after-tax distribution to purchase an annuity contract from a life insurance company. You can then annualize the contract, which simply means converting it into an income stream for the remainder of your life, or your life and that of your surviving spouse. However, if you choose this route, you will eventually consume your principal, so there won't be any money left for your heirs.

Make sure to weigh your options carefully -- large 401(k) distributions don't pop up every day.

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.