Why Roll Over An Ira Into A 401
There are a few reasons you might want to roll a traditional IRA into a 401, though it should be noted you can do this only if your company plan accepts incoming transfers . Here are the pro IRA-to-401 rollover highlights:
Potential for earlier access to that money: If you leave your job, you could start tapping your 401 as early as age 55. Qualified distributions from traditional IRAs cant begin until 59½ unless you start a series of substantially equal distributions a commitment to take at least one distribution per year for at least five years or until you turn 59½, whichever comes last. The distribution amount is based on IRS calculation methods that take into account your IRA balance, age, life expectancy and, in some cases, interest rates. It could mean taking more than you need, for longer than you want to.
Compare costs among your retirement plans to find out where youre getting the better deal.
» See how a 401 could improve your retirement: Try our 401 calculator.
How Do I Complete A Rollover
What Are Your Choices For A Rollover
In general, once you leave a job you have three choices for how to deal with your employer-sponsored retirement plan:
- Leave it with your old employers 401 plan: This approach requires the least amount of work, but may require you to have a minimum amount if you plan to maintain the account there.
- Roll it over into your new employers 401 plan: This approach will require you to file some paperwork, but youll have all your 401 money in one place. This choice can make sense if you like your new employers plan.
- Roll it over into an IRA: This move will require you to file some paperwork, but then youll have the complete freedom to invest the money as you see fit. If you liked the investment options you held in a previous plan, you may still be able to access those via an IRA.
, thats another option for a rollover. But this option is not typical for most individuals.)
If you roll over your 401 into an IRA, youll also want to consider the kind of rollover you need.
- With a Roth 401, youll likely be more interested in a Roth IRA, so that you can maintain the substantial advantages of that plan.
- If you have a traditional 401, then youll probably opt for a traditional IRA.
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Don’t Roll Over Your 401 To An Ira Just Yet
You’ve left your job. What should you do with the 401 plan you’ve faithfully contributed to for years? Conventional wisdom says to roll it over into an individual retirement account , and in many cases, that is the best course of action. But there are times when a rollover is not your best option.
Reasons You May Want To Roll Over Now
- Diversification. Investment options in your 401 can be limited and are selected by the plan sponsor. Rolling your funds over into an IRA can often broaden your choice of investments. More choices can mean more diversification in your retirement portfolio and the opportunity to invest in a wider range of asset classes including individual stocks and bonds, managed accounts, REITs and annuities.
- Beneficiary flexibility. With some IRAs, you may be able to name multiple and contingent beneficiaries or name a trust as the beneficiary. Other IRAs may allow you to impose restrictions on beneficiaries. These options aren’t usually available with 401s. But, keep in mind, not all IRA custodians have the same rules about beneficiaries so be sure to check carefully.
- Ownership control. You are the owner and have access rights with an IRA. The assets in your IRA are also not subject to blackout periods. With a 401 plan, the qualified plan trustee owns the assets and assets may be subject to blackout periods in which account access is limited.
- Distribution options. If your IRA is set up as a Roth IRA, there is not a set age when the owner is required to take minimum distributions. With 401 plans and traditional IRAs, the owner will have to take required minimum distributions by April 1 of the year after they turn age 72.
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Keep Your 401 With Your Previous Employer
In this instance, you wont change a thing. Just make sure that you actively monitor your investments in the plan for performance and remain aware of any significant changes that occur.
If you really like your current investment options and are paying low fees on the investments, this might be the right choice for you.
How To Roll Over A 401 To An Ira In 4 Steps
If you decide to do a 401 rollover to an IRA, typically the money from an old 401 must go into the new IRA account within 60 days. There are four steps to do a 401 rollover into an IRA.
Choose which type of IRA account to open
Open your new IRA account
Ask your 401 plan for a direct rollover or remember the 60-day rule
Choose your investments
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Short Of Cash Be Cautious
It may be tempting to pull money out of your 401 to cover a financial gap. Or, when you are considering rolling money over from a 401 to an IRA, you may wish to roll over only a portion of your retirement savings and take the rest in cash. But do you know the true cost? Use our 401 Early Withdrawal Costs Calculator first.
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What If You Have An Existing 401 At Your Previous Employer
If you have a 401 at a previous employer, youll want to consider whether a rollover makes sense for you. You may want to consult with a tax professional to make sure that you are making a decision that is best for your unique circumstances.
As youre thinking about what to do with your old 401, here are some options to consider:
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Benefits And Risks Of Aggregating Accounts
Another positive of doing a 401 rollover is the ability to consolidate accounts. I crave simplicity in my finances and appreciate the ability to have all my investments in one place.
This decreases the number of funds I hold, allows me to more easily visualize the big picture, and makes performing maintenance tasks such as rebalancing easier.
When you have to take Required Minimum Distributions , having your accounts consolidated also makes this easier. If you have multiple retirement accounts, you have to calculate and take separate withdrawals from each. Find IRS rules regarding this situation here.
There are other benefits to aggregating your accounts. For example, Vanguard offers greater levels of benefits to clients with higher account balances. Most brokerages have similar features to attract additional investments under their management.
However, aggregating your accounts under one roof comes with potential downside. Having all or most of your investments in one place can put us at increased risk in a digital world. Threats range from hackers to computer glitches.
I personally put more value on increased simplicity over the potential risks associated with aggregating investments. However, it is difficult to quantify these benefits and risks, so how this affects your decision will largely come down to personal preference and opinion.
Should I Rollover My 401 To An Ira
The 5 key factors to determine whether you should roll your employer sponsored retirement plan to an IRA are:
Either leaving your money in your 401 or rolling it over to an IRA could be the correct choice for you. I will walk you through my decision process to help you make the best decision for yourself.
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Roll Over Your Money To A New 401 Plan If This Option Is Available
If you’re starting a new job, moving your retirement savings to your new employer’s plan could be an option. A new 401 plan may offer benefits similar to those in your former employer’s plan. Depending on your circumstances, if you roll over your money from your old 401 to a new one, you’ll be able to keep your retirement savings all in one place. Doing this can make sense if you prefer your new plan’s features, costs, and investment options.
- Any earnings accrue tax-deferred.1
- You may be able to borrow against the new 401 account if plan loans are available.
- Under federal law, assets in a 401 are typically protected from claims by creditors.
- You may have access to investment choices, loans, distribution options, and other services and features in your new 401 that are not available in your former employer’s 401 or an IRA.
- The new 401 may have lower administrative and/or investment fees and expenses than your former employer’s 401 or an IRA.
- Required minimum distributions may be delayed beyond age 72 if you’re still working.
Defining Terms: What’s A 401
A 401 plan is a tax-advantaged retirement account typically sponsored by an employer.
The traditional form of the 401 works much like a traditional IRA: Your contributions in a given year reduce taxable income for that year. In a simplified example, if you earn $75,000 and contribute $10,000, your earnings fall to $65,000, saving you tax dollars up front. Your withdrawals will eventually be taxed, though.
401s differ in a few meaningful ways from IRAs:
- Contribution limits: 401s have much higher contribution limits. These typically change annually, but generally you can contribute about three times as much money to a 401 as an IRA.
- Investment options: 401s typically provide limited investment options, with most offering a dozen or fewer mutual funds. In IRAs opened at brokerages, you can invest in virtually any stock exchange-traded fund , or mutual funds.
- Matching funds: Many employers match employee 401 contributions up to a certain percentage of pay.
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Contact Your Current 401 Provider And New Ira Provider
Ideally, you want a direct rollover, in which your old 401 plan administrator transfers your savings directly to your new IRA account. This helps you avoid accidentally incurring taxes or penalties. However, not every custodian will do a direct rollover.
In many cases, youll end up with a check that you need to pass on to your new account provider, Henderson says. Open your new IRA before starting the rollover so you can tell the old provider how to make out the check.
The goal, Henderson says, is to avoid having to ever put the money into your personal bank account.
You only have 60 days to complete the transaction to avoid it being a taxable event, and its best to have everything set up before getting that check, Henderson says.
Begin The Rollover Process
Youll have to fill out paperwork to conduct your rollover and it may require some back-and-forth conversations with your providers. You have several options to actually move the money from the old provider to the new one, but your best option is a direct rollover.
In a direct rollover, the funds are sent straight from your 401 into your new account without you touching the funds. Its important that you specify a direct rollover so that you dont have the check made payable to you. You could trigger a mandatory 20 percent withholding for taxes, and the IRS charges a 10 percent bonus penalty on withdrawals made before age 59 1/2.
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When Not To Transfer To An Ira
You now know some of the benefits of moving your 401 to an IRA. But control over your money isnt the only thing that matters, and you may have other priorities. Its impossible to list every potential pitfall, but a few examples may offer food for thought.
Between age 55 and 59.5
When youre at least 55 years oldbut not yet 59 1/2 years oldyou might want to leave at least some of your money in the 401 plan. 401s allow you to pull money out without penalty after age 55 . IRAs, on the other hand, require that you wait until age 59 ½ to avoid an early-withdrawal penalty of 10% on certain distributions. There are always exceptions and workarounds, but those are the basic rules. If you intend to spend your 401 savings between the ages of 55 and 59 1/2, keep this in mind before making a transfer.
Note: Some public safety workers can avoid early withdrawal penalties from a retirement plan as early as age 50. If you worked for a federal, state, or local government, be sure to explore your options.
Depending on state laws, money in IRAs might be treated differently, and a 401 might offer more protection . Federal law often applies to ERISA-covered 401 plans, while state laws cover IRAs. However, there is some federal protection for IRAs in bankruptcy. When you owe federal tax debts or assets are due to an ex-spouse, protection is usually limited.
RMD While Working
Stable Value Offerings
Fees and Expenses
Losing Access To Superior Investment Options
One potential problem with 401 plans is that your investment options are limited to the choices provided by the plan. On the flip side, some large companies and government plans can use the economy of scale to provide superior investments than retail investors can get on their own.
One example of the latter would include plans that offer ultra-low cost Vanguard Institutional Shares. Another example of a plan with great investment options is the Thrift Savings Plan offered to many government employees.
If your work sponsored retirement account offers acceptable investment options, and especially if it offers superior funds than individual investors can purchase, there are compelling benefits to not roll over your account to an IRA.
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Direct And Indirect 401 Rollovers
Before you roll over your 401, youll need to open an IRA account. You can do this at virtually any major brokerage firm, mutual fund company or robo-advisor. Do some research, then head to your financial institutions website to open your account. At some point, youll want to talk to a customer representative to find out whether the rollover and conversion can be done at once or if they are done sequentially. If its the former case, youll just have to pick your investments once. If its the latter, youll want to keep the money liquid in the IRA before converting to a Roth.
Once youve opened the IRA, you can contact the company managing your 401 account to begin the rollover process. You can do this online or over the phone. Your 401 plan administrator will then transfer your funds into your new IRA account. This is called a trustee-to-trustee or direct rollover, and its the easiest way to do it.
Another path is an indirect rollover. In this case, the balance of the account is distributed directly to you, typically as a check. Youll have 60 days from the date you receive the funds to transfer the money to your custodian or IRA company. If you dont deposit the funds within the 60 days, the IRS will treat it as a taxable withdrawal, and youll face a 10% penalty if youre younger than 59.5. This risk is why most people choose the direct option.