Should I Roll Over My 401k To An Ira

Pros And Cons Of Rolling Over 401k To Ira

Learn the pluses and the minuses of getting all of your IRA and 401k ducks in a row.

According to the Bureau of Labor Statistics, on average, individuals between the ages of 18 and 52 may change jobs as frequently as 12 times. Some of those jobs probably came with some type of employer sponsored retirement plan such as 401k or an IRA account . When switching jobs, many people choose to rollover any accounts to their new employers plan rather than taking them as a withdrawal. When you roll over a retirement plan distribution, penalties and tax are generally deferred. So let’s look at a few of the pros and cons of consolidating them into one IRA with one institution.

If You Have Company Stock

Some retirement savers hold company stock in their 401 alongside other investments. In that situation, if you roll over all those assets to an IRA, you lose the potential to get a more favorable tax treatment on any growth those shares had while in your 401.

It gets a bit confusing, but the idea is that if the company stock has unrealized gains, you transfer it to a brokerage account instead of rolling it over to the IRA along with your other 401 assets. Upon transferring, you are taxed on the cost basis .

However, when you then sell the shares from your brokerage account whether immediately or down the road any growth the stock experienced inside the 401 would be taxed at long-term capital gains rates . This could be less than the ordinary-income tax treatment you’d face if the stock went into a rollover IRA and then were withdrawn.

Here’s an example: If the cost basis of your company stock is $10,000 and the gains on it were $20,000, you would pay ordinary taxes on the $10,000 when you transfer the shares to a brokerage account.

The $20,000 in gains, however, would be taxed at long-term rates once the stock is sold. Any further growth from the point of transfer to sale would be taxed as either short- or long-term gains, depending on how long you held it before selling.

“It’s a complex transaction, and if done incorrectly, the strategy loses its tax advantage,” said CFP Melissa Brennan, a financial planner with ARS Private Wealth in Houston.

Rolling 401 Assets Into An Ira

When you retire or leave your job for any reason, you have the right to roll over your 401 assets to an IRA. You have a number of direct rollover options:

Rolling your traditional 401 to a traditional IRA. You can roll your traditional 401 assets into a new or existing traditional IRA. To initiate the rollover, you complete the forms required by both the IRA provider you choose and your 401 plan administrator. The money is moved directly, either electronically or by check. No taxes are due on the assets you move, and any new earnings accumulate tax deferred.

Rolling your Roth 401 to a Roth IRA. You can roll your Roth 401 assets into a new or existing Roth IRA with a custodian of your choice. You complete the forms required by the IRA provider and your 401 plan administrator, and the money is moved directly either electronically or by check. No taxes are due when the money is moved and any new earnings accumulate tax deferred. Earnings are eligible for tax-free withdrawal once the IRA has been open at least five years and you are at least 59½.

Rolling your traditional 401 to a Roth IRA. If your traditional 401 plan permits direct rollovers to a Roth IRA, you can roll over assets in your traditional 401 to a new or existing Roth IRA. Keep in mind youll have to pay taxes on the rollover amount you convert.

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Benefits From An Ira Rollover

There are some situations where you are allowed to withdraw funds from an IRA before age 59½ without penalty â although youâll still trigger normal income tax. In this case, a rollover from a qualified plan can be beneficial.

What Are The Taxation And Penalties In A 401 Rollover

If you go ahead with a 401 rollover, you have to take heed of the following taxation and penalties:

• While converting your 401 to a Roth IRA, you would have to pay income tax on the funds transferred by you in the year you make the switch. This can be circumvented at the time of your retirement as you would not have to pay any tax on withdrawals provided you have held the account for 5 years and are above 59.5 years of age.
• When you make the switch to a Roth IRA, then the holding period for the transferred funds becomes zero. You must hold the said account for at least 5 years before you can make a withdrawal. Also, you must be 59.5 years or older to ensure penalty-free withdrawals. If you do not adhere to the said rules, you may be subjected to a 10 percent penalty and income taxes.
• If you opt for an indirect rollover, then you must complete the rollover within 60 days from the date you receive your 401 distributions. If you are unable to meet the said deadline, then you would be liable to pay withholding taxes and penalties.

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You May Be Charged Lower Fees

Even if your company covers fees charged by your plan now, it may not once youve parted ways. And you have no guarantee your future companys 401 will be fee-free. Make sure you have a handle on potential costs your employer-sponsored retirement plan has just for managing your money.

While youll probably never be able to escape fund expense ratios, you can minimize or completely eliminate most administrative fees by moving from a 401 to an IRA. An IRA may also afford you better access to more low-cost funds, like index funds.

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 you’d rather have your investments managed for you, or you’d rather do it yourself.

• If you’re 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.

» Ready to get started? Explore best IRA accounts for 2021

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Moving Your 401 To Your New Employer

You can still benefit from the negotiated fees and advice that comes with a 401 without having to keep your account with your old employer â as long as your new employer offers a 401 as well. You can simply move the money from your 401 at your old job to your 401 at your new job.

âMoving the money to a new employerâs plan can be a good option if the investments are solid and costs are reasonable,â Wohlner said. âThis can also be a good way to consolidate 401 accounts giving you one less account to worry about.â

Youâll get largely the same benefits from moving to a new employerâs 401 as you would by keeping the plan with your old employer. But another big benefit, according to LeVitre: âyour old and new retirement money will be consolidated in one retirement account.â

The downside: You may have had different investment options at your old employer versus your new one, which would give you more opportunities to pick different investments. âLimited investment options and diversification,â are a con of rolling your plan over, LeVitre said.

Rolling Into A Traditional Ira

Choosing to roll your traditional 401 to a traditional IRA preserves your tax-free money. In this case, your total account would be transferred over to an IRA and no taxes would be due until its time to withdraw. This can be a better solution if you anticipate having a lower tax rate in the future.

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Unsatisfactory 401 Investment Performance

A rollover may be a better idea in case your company 401 plan is not performing well. For instance, if the market rises by 40 percent over a few years, while your 401 rises by just half that amount over the same time interval, then a rollover is worth considering.

Although IRAs provide the opportunity to match market performance, there is no guarantee that you can actually perform better than the market.

One thing I did with my 401 was moved it to a robo-advisor . If funds are underperforming, it will auto-correct and rebalance for me.

Wealthfront also allows me to create the investment portfolio that works for me. Whether thats by editing one of its existing investment portfolios or creating my own from scratch with ETFs that I am passionate about be it healthcare, clean energy, or tech.

Benefits Of A Rollover Into A New 401

Distributions at 55: Under an IRS provision known as the Rule of 55, you can withdraw funds from your current companys 401 penalty-free starting at age 55, instead of 59.5 . By combining 401s, you may have access to your older assets at 55.

Loan options: By rolling over an old 401 into a new plan, you may be able to borrow against the account, which is not an option with a 401 that remains with a former employer.

Lower fees: As stated above, the fees associated with your new employers plan may be lower than those of your former plan or a future IRA.

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A Closer Look At Your Available Options

The good news is whatever money thats in your 401 is yours to do with as you like. But when you no longer work for a company, any retirement accounts you have through your former company might need to be moved to your new employer. Or you may need to roll it over or into a brokerage account that you own completely.

Move Your Old 401 Assets Into A New Employers Plan

You have the option to avoid paying taxes by completing a direct, or trustee-to-trustee, transfer from your old plan to your new employers plan, if the employers plan allows it.

It can be easy to pay less attention to your old retirement accounts, since you can no longer contribute. So, transferring old 401 assets to your new plan could make it easier to track your retirement savings.

You also have borrowing power if your new retirement plan lets participants borrow from their plan assets. The interest rate is often low. You may even repay the interest to yourself. If you roll your old plan into your new plan, youll have a bigger base of assets against which to borrow. One common borrowing limit is 50% of your vested balance, up to $50,000. Each plan sets its own rules.

Here are a few important steps to take to successfully move assets to your new employers retirement plan so as not to trigger a tax penalty:

Step 1: Find out whether your new employer has a defined contribution plan, such as a 401 or 403, that allows rollovers from other plans. Evaluate the new plans investment options to see whether they fit your investment style. If your new employer doesnt have a retirement plan, or if the portfolio options arent appealing, consider staying in your old employers plan. You could also set up a new rollover IRA at a credit union, bank, or brokerage firm of your choice.

The instructions you get should ask for this type of information:

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Drawbacks Of Keeping Your 401 With A Former Employer

There are potential drawbacks to this strategy, which may lead you to roll over your account into a new plan.

Multiple accounts to manage: Keeping your 401 with your former company means youll have more than one retirement account to track. For some investors, that may be one too many accounts to juggle.

Contributions end: While the money in your old 401 will continue to grow tax-deferred, you will no longer be able to contribute to the account.

Communication: You may be out of the loop about important updates concerning your account if information about your former employers plan is distributed via company email.

Higher fees: Its possible that fees and expenses attached to your former employers plan are higher than what is offered by your new company. Remember to check the fee disclosure notice of any plan that youre in or thinking of joining.

What To Consider When Choosing A Broker

If youre planning to roll over your 401 into an IRA, youll likely be most concerned with a broker that can do the following things best. Most brokers do offer an IRA, but some popular ones do not, but the brokers below all offer IRAs. We also considered the following factors when selecting the top places for your 401 rollover.

• Price: Trading commissions for stocks and ETFs have fallen to $0 at most online brokers, and thats great for investors. But there are other costs, too, perhaps most notably account fees, such as fees for transferring out of your account.
• No-transaction-fee mutual funds: The brokers in the list below offer thousands of mutual funds without a transaction fee. If youre rolling over your 401 and you like the mutual funds you have already, these brokers may allow you to buy and sell the same one without a fee.
• Investing strategy: While a 401 may limit your investing options to a pre-selected group of mutual funds, an IRA gives you the ability to invest in almost anything trading in the market. So we considered how each broker might fit an investors needs.

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Rolling Over To A New 401

If youre moving to a different employer that also offers a 401, then you might consider rolling your balance over to the new company. The benefit of this option is the simplicity youll have just one retirement account to keep track of, rather than multiple accounts.

In most cases, this type of rollover can be as easy as filling out a few online forms, and the companies that manage your 401s can usually take care of things on their end.

This process is most frequently initiated by paperwork from the receiving 401 plan, Deering says. For example, if my 401 was at T. Rowe Price and I wanted to roll over an older 401 plan I had at Fidelity, I would contact T. Rowe Price to get their rollover paperwork and submit it to Fidelity to make the check distribution.

Pretax Contributions May Be Right For You If:

• You anticipate lower income taxes in retirement. You can save money by lowering your taxable income now and paying taxes on your retirement funds later.
• Youd want to save for retirement while reducing your take-home salary. When you make pretax contributions, you pay less in taxes now, whereas Roth contributions reduce your salary even more after taxes are deducted.

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How Much Money Do I Need To Open A Vanguard Ira

At Vanguard, you can open an account with a $0 balance. But there are a few minimums to keep in mind as you begin to invest.

• Vanguard ETFs: You only need enough money to cover the price of 1 share, which can generally range from $50 to a few hundred dollars.
• Vanguard mutual funds: Some Vanguard mutual funds have a $1,000 minimum . Most of our other Vanguard mutual funds have a $3,000 minimum.

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