Rolling The Assets Into An Ira Or Roth Ira
Moving your funds to an IRA is the route financial experts advise in most instances. “Now you’re in charge and you have more investment flexibility,” said Smith. Try not to go it alone, he advises. “Once you roll the money over, it’s you making the decisions, but getting a financial professional should be the first step.”
Your first decision: whether to open a traditional IRA or a Roth.
Traditional IRA. The main benefit of a traditional IRA is that your investment is tax-deductible now you put pre-tax money into an IRA, and those contributions are not part of your taxable income. If you have a traditional 401, those contributions were also made pre-tax and the transfer is simple. The main disadvantage is that you have to pay taxes on the money and its earnings later, when you withdraw them. You are also required to take an annual minimum distribution starting at age 70½, whether if you’re still working or not.
Roth IRA. Contributions to a Roth IRA are made with post-tax income money you have already paid taxes on. For that reason, when you withdraw it later neither what you contributed nor what it earned is taxable you will pay no taxes on your withdrawals. Investing in a Roth means you think the tax rates will go up later, said Rain. “If you think taxes will increase before you retire, you can pay now and let the money sit. When you need it, it is tax-free,” said Rain.
Keeping Your 401 With Your Former Employer
If your former employer allows you to keep your funds in its retirement account after you leave, this may be a good option, but only in certain situations, says Colin F. Smith, president of The Retirement Company in Wilmington, N.C.
Staying in the old plan may make sense “if you like where you are and they may have investment options you can’t get in a new plan,” says Smith. “The other main advantage is that creditors cannot get to it.”
Additional advantages to keeping your 401 with your former employer include:
- Maintaining the money management services.
- Special tax advantages: If you leave your job in or after the year you reach age 55 and think you’ll start withdrawing funds before turning 59½, the withdrawals will be penalty free.
Some things to consider when leaving a 401 at a previous employer:
- If you plan on changing jobs a few more times before retirement, keeping track of all of the accounts may become cumbersome.
- You will no longer be able to contribute to the old plan and in some cases, may no longer be able to take a loan from the plan.
- Your investment options are more limited than in an IRA.
- You may not be able to make a partial withdrawal and may have to take the entire amount.
- If your assets are less than $5,000 you may have to proactively remain in the plan. If you don’t notify your plan administrator or former employer of your intent, they may automatically distribute the funds to you or to a rollover IRA.
Where Should You Transfer Your 401
You have several options on what to do with your 401 savings after retirement or when you change jobs. For example, you can:
The right choice depends on your needs, and thats a choice everybody needs to make after evaluating all of the options.
Want help finding the right place for your retirement savings? Thats exactly what I do. As a fee-only fidicuary advisor, I can provide advice whether you prefer to pay a flat fee or youd like me to handle investment management for you, and I dont earn any commissions. To help with that decision, learn more about me or take a look at the Pricing page to see if it makes sense to talk. Theres no obligation to chat.
Important:The different rules that apply to 401 and IRA accounts are confusing. Discuss any transfers with a professional advisor before you make any decisions. This article is not tax advice, and you need to verify details with a CPA and your employers plan administrator. Likewise, only an attorney authorized to work in your state can provide guidance on legal matters. Approach Financial, Inc. does not provide tax or legal services. This information might not be applicable to your situation, it may be out of date, and it may contain errors and omissions.
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Option : Roll It Into Your New 401
If your new employer offers a 401, you can possibly roll your old account into the new one. You may be required to be with the company for a certain amount of time before youre eligible to participate in their plan.
You can choose to do a Direct Rollover, whereby the administrator of your old plan transfers your account balance directly into the new plan. This only requires some paperwork.
Or, you can choose an Indirect Rollover. With this option, 20% of your account balance is withheld by the IRS as federal income tax in addition to any applicable state taxes. The balance of your old account is given to you as a check to deposit into your new 401 within 60 days. There is one catch, though. Youll need to deposit the entire amount of your old account into your new account, even the amount withheld for taxes. That means using personal cash to cover the difference and waiting until tax season to be reimbursed by the government.
How 401 Rollovers Work
If you decide to roll over an old account, contact the 401 administrator at your new company for a new account address, such as ABC 401 Plan FBO Your Name, provide this to your old employer, and the money will be transferred directly from your old plan to the new or sent by check to you , which you will give to your new companys 401 administrator. This is called a direct rollover. Its simple and transfers the entire balance without taxes or penalty. Another, even simpler option is to perform a direct trustee-to-trustee transfer. The majority of the process is completed electronically between plan administrators, taking much of the burden off of your shoulders.
A somewhat riskier method, Ford says, is the indirect or 60-day rollover in which you request from your old employer that a check be sent to you made out to your name. This manual method has the drawback of a mandatory tax withholdingthe company assumes you are cashing out the account and is required to withhold 20% of the funds for federal taxes. This means that a $100,000 401 nest egg becomes a check for just $80,000 even if your clear intent is to move the money into another plan.
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The Tax Withholding Complication
Unless youre planning to actually liquidate your plan distribution, you should always go with either the direct rollover method or the trustee-to-trustee method. In my opinion, the trustee-to-trustee method is the simplest, since the funds are transferred directly and immediately from one plan to another. Theres no possibility of human error, that might cause you to miss the 60-day deadline.
But if for any reason you have taxes withheld from your transfer, theres a major complication. The amount of tax withheld from the distribution means that less than 100% is available to be transferred to the new plan.
Lets say you transfer $50,000 from an employer-sponsored plan to an IRA. The plan administrator is required to withhold 20%, or $10,000.
For tax purposes, the full $50,000 will be taxable. But you will only receive $40,000, due to the withholding.
If youre going to take the distribution and keep it, theres no problem. The taxes for the distribution will already have been withheld.
However, if you ultimately plan the roll the funds over into a new plan, youll only have $40,000 distributed to make the transfer. That will leave you with one of two choices:
Confirm A Few Key Details About Your 401 Plan
First, get together any information you have on your old 401. Its okay if you dont have a ton, but any details like an old account statement or an offboarding e-mail from your former HR team can help. 401 paperwork can be confusing, so just focus on identifying the following three items:
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This Rollover Is Taxable
A 401 rollover to a Roth IRA changes the tax treatment of your money, which DOES cause a taxable event. Your 401 money is pre-tax, whereas Roth IRA contributions are post-tax, so this conversion will have you adding on the rollover money to your income taxes in the year in which you make the switch.
Chief Investment Adviser of Impact Advisors LLC and CFA Jason Escamilla cautions that you can only do this conversion once and that youll need to be aware of income limits to enjoy the full tax benefit.
If you were between jobs for a while or otherwise in a lower-income / lower tax bracket year, if you do not roll over to the current-company 401, you have the option to convert the old plan to a Roth IRA. But you lose this option once you roll over into another 401 plan.
For both options, the name of the game is consolidation. Having all of your 401 assets in one place simply makes sense, but it also means youre not paying fees to 5 different institutions. Whether or not you want to be actively investing in these accounts is up to you, but its important to make sure youre with an institution and advisor you feel comfortable speaking with about your retirement investments.
Disadvantages Of An Ira Rollover
A rollover is not for everyone. A few cons to rolling over your accounts include:
- . You may have credit and bankruptcy protections by leaving funds in a 401k as protection from creditors vary by state under IRA rules.
- Loan options are not available. The funds may be less accessible. You may be able to get a loan from an employer-sponsored 401k account, but never from an IRA.
- Minimum distribution requirements. You can generally withdraw funds without a 10% early withdrawal penalty from a 401k if you leave your employer at age 55 or older. With an IRA you generally have to wait until you are age 59 1/2 to withdraw funds in order to avoid a 10% early withdrawal penalty. The Internal Revenue Service offers more information on tax scenarios as well as a rollover chart.
- More fees. You may be responsible for higher account fees as compared to a 401k which has access to lower-cost institutional investment funds because of group buying power.
- Tax rules on withdrawals. You may be eligible for favorable tax treatment on withdrawals if your 401K is invested in company stock.
Neither State Farm nor its agents provide tax or legal advice.
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Do I Have A Deadline To Take Money Out Of My Old 401
When you leave a job, you arent forced to decide what to do with your 401 immediately.
The money already in your 401 is yours, so you can usually leave it as long as you want or roll it into an IRA at any time.
However, there are a few exceptions:
- If you contributed less than $5,000 to your 401, your employer is legally allowed to tell you to take the money and move it elsewhere .
- Contributions of $1,000 to $5,000 are subject to involuntary cash-outs. Thats when your former employer moves the full amount into an IRA.
- If you contributed less than $1,000, your former company can mail you a check for the full amount. You can deposit this amount into another retirement account within 60 days to avoid tax penalties.
Option : Leave Your Money Where It Is
Usually, if your 401 has more than $5,000 in it, most employers will allow you to leave your money where it is. If youve been happy with your investment options and the plan has low fees, this might be a tempting offer. Before you decide, compare your old plan with any retirement plans offered at your new job or with an IRA of your own.
Your new employer-sponsored plan might have more limitations on it than your previous plan or other available options. Maybe there are fewer investment choices/options. Maybe it doesnt have an employer match or higher management fees. So youll want to look closely.
Also consider how often you tend to stay at jobs. If you change jobs every few years, you could end up with a trail of 401 plans at all the different places youve worked. Consolidating might be easier in the long run.
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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 arenât 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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How Much Does It Cost To Roll Over A 401 To An Ira
If you do the process correctly, there should be few or no costs associated with rolling over a 401 to an IRA. Some 401 administrators may charge a transfer fee or an account closure fee, which is usually under $100.
Because moving your money from a 401 to an IRA allows you to avoid the 10% early withdrawal penalty that results if you withdraw money from a 401 before 59 1/2, itâs a far better option if you canât keep your money invested in an old employerâs plan or move it to a 401 at your new company.
You should consider whether rolling over a 401 to an IRA is a better option than either leaving it invested when you leave your job or moving the money to your new employerâs retirement plan. If you can avoid 401 management fees and gain access to investments with lower expense ratios, an IRA may be a cheaper account option.
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Open Your New Ira Account
You generally have two options for where to get an IRA: an online broker or a robo-advisor. The option you choose depends on whether youre a manage it for me type or a DIY type.
If youre not interested in picking individual investments, a robo-advisor can do that for you. Robo-advisors build personalized portfolios using low-cost funds based on your preferences, then rebalance those funds over time to help you stay on track, all for a much lower fee than a conventional investment manager.
If you want to build and manage your own investment portfolio, an online broker lets you buy and sell investments yourself. Look for a provider that charges no account fees, offers a wide selection of low-cost investments and has a reputation for good customer service.
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