Better Understand Your Retirement Finances
If youre taking the active steps to roll over your retirement account, youve spent at least some time thinking about how this might work. Perhaps youve even gone far enough to research the mechanics. When it comes to personal finance knowledge, more is always more, so its a good idea to learn about these transfers when you have to set one in motion.
Rolling Over To A New 401
The first step in transferring an old 401 to a new employer’s qualified retirement plan is to speak with the new plan sponsor, custodian, or human resources manager who assists employees with enrolling in the 401 plan. Because not every employer-sponsored plan accepts transfers from an outside 401, it is imperative for a new employee to ask if the option is available from the new employer. If the plan does not accept 401 transfers, the employee needs to select one of the three other options for the 401 account balance.
If the new employer plan accepts 401 transfers from other companies, there is often a substantial amount of paperwork that must be completed by the employee. The paperwork is provided by the new plan sponsor or human resources contact and requires the name, date of birth, address, Social Security number, and other employee identifying information.
In addition, the 401 transfer form must provide details of the old employer plan, including total amount to be transferred, investment selections held in the account, date contributions started and stopped, and contribution type, such as pre-tax or Roth. A new plan sponsor may also require an employee to establish new investment instructions for the account being transferred on the form. Once the transfer form is complete, it can be returned to the plan sponsor for processing.
A transfer from one 401 to another is a tax-free transaction, and no early withdrawal penalties are assessed.
Pick An Ira Account Type
There are two main types of IRAs that you can transfer 401 funds to: a traditional IRA or a Roth IRA. As we mention above, most people roll over their money into an account that has the same tax benefits as the one theyre transferring from.
For instance, lets say you have a traditional 401 account that allows you to contribute money and deduct it from your taxable income, all while staving off income taxes until you withdraw in retirement. In order to maintain this tax-deferred status, youll need to roll your 401 asset over into a traditional IRA. You still have the option of rolling over to a Roth IRA, though thatll mean youll pay taxes on that money for the current year.
On the flip side, those with a Roth 401 gain the perk of tax-free growth since the money they contribute has already had taxes paid on it. Because of this, the IRS does not allow Roth 401 account holders to roll funds over to anything but a Roth IRA or another Roth 401.
Only you can choose which type of IRA is best for your situation. If you can figure out whether your tax rate is higher now than it will be in retirement, then that should lead you in the right direction. You could also speak with a financial advisor if you have further questions.
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You Get To Consolidate Accounts
Usually when people work on their financial plans, the first thing they start to tackle is improving organization and clarity around their money. Consolidation helps achieve those goals.
When you have a large number of accounts all scattered across multiple institutions, its a lot to manage. Its hard to track balances, fees, and all the other little details associated with each account that you need to know. It makes things more complicated than they need to be when having everything in one place is an option.
Not to mention, when you reach your official retirement and need to take withdrawals from your retirement accounts, having them all at one financial institution is really helpful. If you have 10 different retirement account with 10 different institutions, you have to create withdrawal strategies and processes for each one.
Youll either need to work to consolidate everything at that point, or work with all of your old employers and financial institutions to coordinate those withdrawals. Consolidation means one less thing you need to worry about with your finances.
There Are A Lot Of Reasons Why Rolling A 401 Over Into Your Own Ira Is The Best Choice For Most People But For Some There Are A Couple Of Cons That Could Outweigh The Pros
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Most of us have worked for a company that offered 401 plans to their employees. In fact, you and I have likely worked for multiple companies that provide this benefit. And as a result, you might have a number of 401 plans to your name if you opened an account with each employer.
Thats not necessarily a bad thing. After all, most people should always use a 401 if their employer offers one even if the employer doesnt match. 401s are powerful tax-advantaged accounts that you should take advantage of, whether or not your company chips in, too.
So lets say youve been diligently pumping money into your 401 at every company that offered one. But then you changed jobs. You started a new 401 at that new company and then got busy and left the old accounts behind . What happens to all those old accounts? Should you do anything about them?
Maybe. Its important to understand what you can do with old 401s from previous employers and then know the right choice to make for managing those accounts. Heres what you should know.
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Leave It In Your Current 401 Plan
The pros: If your former employer allows it, you can leave your money where it is. Your savings have the potential for growth that is tax-deferred, youll pay no taxes until you start making withdrawals, and youll retain the right to roll over or withdraw the funds at any point in the future.
The cons: Youll no longer be able to contribute to the plan, and the plan provider may charge additional fees because youre no longer an employee. Managing multiple tax-deferred accounts can also prove complicated. The IRS mandates required minimum distributions annually from all such accounts beginning at age 72 . Fail to calculate the correct amount across multiple accounts, and the IRS will slap you with a 50% penalty on the shortfall.
How A Roth Ira Conversion Can Leverage Currently Low Tax Rates
One of the potentially overlooked silver linings of the past years economic challenges is a favorable income tax environment created by the 2017 Tax Cuts and Jobs Act. If youre considering a Roth IRA conversion1 from your 401, youll be paying some of the lowest tax rates in history on those converted assets and doing it all at one time. However, if you went with a traditional IRA rollover, you may pay higher taxes in retirement on your RMDs.
If youve lost your job, or your income level drops, you can convert your 401 assets at your new, lower, tax bracket. Say, for example, you convert your 401 assets to a Roth IRA, you may be paying taxes at a reduced rate right off the bat, explains Markwell. And if taxes rise between now and your retirement target date, at which time youd otherwise take distributions, you will have further benefited tax-wise from that earlier conversion.
Keep in mind that establishing an IRA with efficient growth goals may call for more active management on your part, depending on your retirement goals. A financial professional can help tailor your investments to your individual strategy and also help you revisit and refine that plan as needed.
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How To Roll Over Your 401 To Your New Employer
Rollovers arent always the easiest things to accomplish which is why so many accounts are left behind. To properly complete a rollover, follow these steps:
Once the rollover is complete, it becomes part of your new 401 balance, and you can manage it and invest it as one account.
Are There Any Downsides To Rolling Over My 401
Yeah, it can come with a couple of cons, depending on your new employers 401 provider. Like worse investment options or higher fees. Though you will be able to choose your investments, the plan provider decides which ones to offer you. And you may have to pay a higher rate on your investments. Even if it initially sounds like a small difference, it can add up over time.
Before you start weighing your options, heres some help with the language of retirement.
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Rollover The Money Into An Ira
If you moved to a higher-paying job, you should consider a rollover IRA to get greater control over your investments. A rollover IRA allows you to combine all your old 401s so that you have a single location for your retirement money.
Unlike a 401 where you are the participant, an IRA gives you full ownership of your retirement savings, and you can make decisions on your portfolio composition, and how much to invest in each type of security. You can also choose to convert your IRA account into a Roth IRA account if you think that your retirement income will be higher than your current income.
You Can Still Roll Over Cash Outs From A 401
If you do receive a cash out from your previous 401, it may be wise not to spend that check. For example, if you spend a $900 cash out instead of rolling it over into an account earning 8% tax-deferred earnings, your retirement fund could miss out on more than $8,000 in growth after 30 years*. The bigger your cash out, the higher your opportunity cost may be.
If youre able to open an IRA that accepts the cash out check within 60 days from your last day of employmentconsider taking advantage of an indirect rollover to recoup withholdings and avoid paying penalties.
Youll have to deposit the cash out check as an indirect rollover. Any portion of the gross amount of the cash out that you do not roll into an IRA will be considered taxable income to you. Therefore, you should also deposit any federal and state withholdings originally taken from your cash out distribution and roll that into your IRA as well. If you do this within the 60 day period following your cash out distribution, the rollover amount will not be taxable to you and the withholding on the distribution will be used towards any taxes you owe to the IRS when you file your next tax return. If you do not owe taxes, the withholdings will be returned to you via a tax refund.
To help avoid any issues, we think its smart to review your distribution options early after you terminate employment, and request a rollover distribution to a qualified plan or IRA of your choice before your employer forces you to take one.
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Taking The Cash Distribution May Cost You
Avoiding cash distributions can save you from taxes and penalties, because any amount you fail to roll over will be treated as a taxable distribution. As a result, it would also be subject to the 10% penalty if you are under age 59 1/2.
Since the taxable portion of a distribution will be added to any other taxable income you have during the year, you could move into a higher tax bracket.
Using the previous example, if a single taxpayer with $50,000 of taxable income were to decide not to roll over any portion of the $100,000 distribution, they would report $150,000 of taxable income for the year. That would put them in a higher tax bracket. They also would have to report $10,000 in additional penalty tax, if they were under the age of 59 1/2.
Only use cash distributions as a last resort. That means extreme cases of financial hardship. These hardships may include facing foreclosure, eviction, or repossession. If you have to go this route, only take out funds needed to cover the hardship, plus any taxes and penalties you will owe.
The CARES Act, enacted on March 27, 2020, provided some relief for those who need to make withdrawals from a retirement plan. It lifted penalties for withdrawals made through December 2020 and provides three years to pay back any early withdrawals.
Roll It Into A New 401 Plan
The pros: Assuming you like the new plans costs, features, and investment choices, this can be a good option. Your savings have the potential for growth that is tax-deferred, and RMDs may be delayed beyond age 72 if you continue to work at the company sponsoring the plan.
The cons: Youll need to liquidate your current 401 investments and reinvest them in your new 401 plans investment offerings. The money will be subject to your new plans withdrawal rules, so you may not be able to withdraw it until you leave your new employer.
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What Are The Steps I Need To Follow To Roll Over A 401 To My New Employer
There is a specific way to transfer a 401 to new job that is tax-free. The simplest is for investors to have their 401 account transferred directly to another 401 or IRA without any taxes being withheld.
The other option is for an investor to have their old plan administrator send them a check for the funds, which they are responsible for depositing into the new retirement savings account. Under this option there is a window of 60 days to complete the rollover.
Hereâs the fine print to be aware of and why this route is not ideal: If a distribution check is made out to you personally, rather than to the next fund, 20% must be withheld for taxes. If the individual investor wants to defer tax from the distribution theyâll need to fund the difference based on what was withheld with other sources of income. When tax time hits, if the full amount is rolled over, itâs possible to get a refund of the taxes withheld. Not adding the extra amount withheld may result in a 10% early withdrawal penalty as well.
Investors who donât want 20% withheld should ask the old plan to issue the check to the next fund. Even if the old plan mails the check to the investor, as long as itâs made out to the next fund, no withholding is needed.
To avoid taxes being withheld, choose the direct transfer option between your old 401 and your new 401. Hereâs how to rollover 401 to new employer.
Con #: You Have No Choice In What Funds Your Former Employers Choose
Since your former company administrates the retirement plan, youll only be able to select funds from the options they provide. For example, if youve read some great information about a mutual fund that focuses on sustainable agriculture but your plan doesnt offer it, youll need to go elsewhere to invest in it. You’re losing the flexibility that you could have with a traditional or Roth IRA, adds Markwell.
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Changing Jobs Options For Your 401 Plan
If you have a 401 plan, you are familiar with the benefits afforded by these popular retirement accounts. They are a great way to set aside pre-tax earnings and enjoy tax-deferred investments that have the potential to grow over the years, especially if your employer matches your contributions.
But what will happen to that nest egg if you leave your company to take another job? Maybe little or nothing at all, if you transfer the money to another qualified plan. Or, you might face a big tax bill and a government penalty if you prematurely withdraw funds.
Employees who leave their companies have several options when it comes to their 401 plans, and each option has advantages and disadvantages.
Keep your old 401 where it is and start another one at your new job
This option avoids the possibility of taxes and penalties, and your money will continue to grow tax-deferred. Another potential advantage is this: If your old and new companies offer plans with differentyet complementaryinvestment options that meet your needs, you will be able to enjoy the benefits of both plans.
Before making any decision, ask your former employer if your access to money in the existing 401, such as borrowing against it, will be restricted once you leave the company. It should also be noted that another possible drawback to having two accounts is just thatthere will be two sets of records to track.
Roll over existing 401 assets to an IRA and start another 401 at your new job