Leave Your Account Where It Is
Many companies allow you to keep your 401 savings in their plans after you leave your job. Often that’s only if you meet a minimum balance requirement, typically $5,000. Since this option requires no action, it is often chosen by default. But leaving your 401 where it is isnt always a result of procrastination. There are some valid reasons to do it.
You can take penalty-free withdrawals from an employer-sponsored retirement plan if you leave your job in or after the year you reached age 55 and expect to start taking withdrawals before turning 59 1/2.
Other reasons you may want to keep your retirement plan where it is include:
Tips For 401 Rollovers
- Need more help deciding whether to roll over your 401? Consider working with a financial advisor to solidify your retirement plan. SmartAssets financial advisor tool can match you with up to three local financial advisors, and you can choose the one who is best for you. If youre ready, get started now.
- Compare the fees of various plans by locating their fee disclosure notices. Youll want to pay attention to asset-based fees and administrative fees.
- Your 401 may include shares of company stock. If you want to estimate your tax liability when rolling it over, SmartAssets capital gains tax calculator and income tax calculator can help you figure it out.
When Not To Roll Over Your Retirement Account
There can be good reasons to NOT roll over an old 401 or 403 to an IRA. For tax reasons, its generally not a good idea to roll over company stock that has appreciated in value.
Second, if youre afraid of bankruptcy or are planning to retire early, leveraging your employers 401 or 403 provides additional protection from creditors and could allow you to take out funds before age 59 ½ without penalty.
Finally, while this is not a reason to avoid a rollover to an IRA, its important to note that many financial professionals will get a commission if you use them to roll your dollars to an IRA, but not if you roll your dollars to your new 401.
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You Get More Investment Options
When you invest money in a 401, youre limited to a select menu of investments available in that particular plan. You might get 10 or 15, and rarely more than 20 or 25. You dont necessarily need a lot of options to build a good portfolio, but more options does mean more to choose from . Using an IRA gives you the opportunity to shop the market and find lower-cost funds to use that better match your financial goals.
Why Transfer Your 401 To An Ira
Why would you move savings from an old 401 plan to an IRA? The main reason is to keep control of your money. In an IRA, you get to decide what happens with the funds: You choose where to invest and how much you pay in fees, and you dont need anybodys permission to take money out of the account.
Cost and providers: In your 401, your employer controls almost everything. Employers choose vendors for the plan, which determines the investment lineup available. Those might not be investments you like, and they might be more expensive than you want. If you want to practice socially-responsible investing, the 401 may lack options for that.
Timing: 401 plans also require extra steps when you want to withdraw funds: An administrator needs to verify that you are eligible to access your money before youre allowed to take a distribution. Plus, some 401 plans dont allow partial withdrawalsyou might need to take your full balance.
If you need access to your 401 savings for any reason, its easier when the money is in an IRA. In most cases, you call your IRA provider or request a withdrawal online. Depending on what you own in your account, the funds might go out as soon as the next business day. But 401 plans might need a few extra days for everybody to sign off on the distribution.
Control Tax Withholding
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Leave It With Your Old Employer
As long as your 401 balance is $5,000 or more, you can leave the money in your former employer’s plan. Doing this for a relatively short time may make sense. For example, if you were laid off and don’t have a new job yet, you may want to leave your existing 401 as is until you get a new job that offers a 401, and then do a rollover .
Technically, your 401 money can remain in your former employer’s plan as long as you want it to, but there are some good reasons not to leave it there indefinitely. For one thing, if you start contributing to a 401 plan through your new employer and leave your existing plan intact, you’ll be paying fees on two accounts. These costs can quickly add up, which will eat into your investment earnings. Additionally, if your focus is split between two accounts, you may not be as diligent about monitoring your account and rebalancing your investments as you would if you were concentrating on one plan with your current employer. Another hazard: Your former employer could go out of business. If this happens, your 401 balance is still safe, but accessing the account or rolling over funds may become more complicated.
Rolling Into An Ira Stay On Top Of The Move
If you decide to roll over your 401 into an IRA not sponsored by your new employer, your IRA sponsor or advisor will help guide you through the process to ensure the money gets to the proper destination in a timely manner.
Be sure your new broker/advisor has experience with rollovers, especially if you have company stock in your 401. Why? Because company stock is liquidated when its rolled into an IRA, and later, when distributed, may be taxed as ordinary income resulting in a higher tax liability.
As recommended above, stay vigilant until your money is safely in its new home and that you have proof typically verified online through the IRA providers website.
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Roll The Assets Into An Ira
Your 401 assets are already in a tax advantaged account and rolling your 401 into an IRA will keep your investments growing with the same tax advantages and you will avoid the 10% early withdrawal penalty.
Possible Advantages: In addition to avoiding the 10% early withdrawal penalty and maintaining tax advantages, there are several other important benefits to rolling your 401 into an IRA. The biggest advantage is that you control your investment options and you are no longer limited to the investment options in your old or new 401 plan. This is important because you can limit your expenses and you maintain control over your accounts. Some companies change trustees and it is not your old companys duty to notify you of any changes, it is up to you to keep track. Keep in mind that rolling your 401 assets into an IRA plan isnt final you may be able to roll it into your new 401 plan later. You also maintain flexibility for beneficiaries.
Possible Disadvantages: You will not be able to take loans from your IRA as you would be able to if you rolled it into your new employers plan. There are also several disadvantages regarding withdrawals from an IRA vs. a 401 in certain circumstances, 401 plans have a little more flexibility.
How To Transfer From Your 401 To An Ira
When youre ready to make the transfer, you need to do three things:
Unfortunately, you typically have to go through your former employer or a vendor they use. With many 401 plans, you cannot request a transfer using paperwork from the receiving IRA custodian.
Who to Contact
If you work for a large company, you can most likely contact your 401 provider directly. For example, contact Fidelity, Vanguard, or whatever website you use to manage your account. Alternatively, call whoever prints your 401 statements. If you work for a small company, you may need to contact the human resources department, which might just be the person who hired you. Either way, you eventually need one of the following:
A financial advisor like me can guide you through the process if you have questions.
What to Say
Where to Deposit
Indirect vs. Direct Rollovers
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Indirect Rollovers Can Be Complicated To Manage
With an indirect rollover, you receive a check for the balance of your account that is made payable to you. That might sound good, but as a result, you are now responsible for getting it to the right place. You have 60 days to complete the rollover process of moving these assets to your new employer’s plan or an IRA.
If you dont complete the rollover within this 60-day window, you will owe income taxes on the amount you failed to roll over. If you’re under 59 1/2, you will also face a 10% penalty tax. Indirect rollovers can be made once a year.
Your old employer is required to withhold 20% from your distribution for federal income tax purposes. To avoid being taxed and penalized on this 20%, you must be able to get enough money from other sources to cover this amount and include it with your rollover contribution.
Then, youll have to wait until the following year, when you can file your income tax return to actually get the withheld amount back.
Suppose the 401 or 403 from your prior employer has a balance of $100,000. If you decide to take a full distribution from that account, your prior employer must withhold 20%. That means they keep $20,000 and send you a check for the remaining $80,000.
Even if you have an extra $20,000 on hand, you still must wait until you file your income tax return to get the withheld $20,000 returnedor a portion of it, depending on what other taxes you owe and any other amounts withheld.
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.
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You Might Be Missing Out On Better Investments
401 accounts grow at different rates depending on which assets you invest in. If the retirement savings plan at your new companyor an individual retirement plan offers a selection of stocks and bonds that better aligns with your financial goals, it might be time to initiate a rollover.
The money thats sitting in your old 401 could potentially grow at a faster rate if you roll it over into a new plan or into an IRAits certainly worth investigating the growth rates of each. Keep in mind that investors can lose money when investing, too, so it always makes sense to consider your personal risk tolerance when deciding how to invest your retirement accounts.
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.
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Withdraw The Assets In A Lump Sum
Withdrawing your assets from your 401 plan is not something most people will recommend because you will be hit with taxes and early withdrawal penalties, which could eat up nearly a third of your total assets to that point.
Possible Advantages: Your assets will be available for immediate use.
Disadvantages: You will face the immediate tax impact of paying income taxes on the lump sum of the assets you withdraw , and you will also have to pay a 10% early withdrawal penalty if you are under age 59½. You will also lose tax deferral benefits on your funds, miss out on potential future earnings, and you will lock in any market losses that had occurred up to that point. Most importantly, you can severely reduce the amount of money you have for retirement.
You can change your mind within 60 days. Your old fund manager is required to deduct 20% for taxes when you withdraw your funds. If you change your mind and decide to roll the funds over, there is the 60-day rollover rule which allows you to roll the money into an IRA within 60 days. However, you will be required to come up with the 20% difference to reinvest the entire amount and avoid paying income taxes. You will get the 20% back when you file taxes the following year as long as you complete the rollover within 60 days.
Delay Required Mandatory Distributions
Workers with traditional IRAs and 401s both face the same reality when it comes to taking mandatory distributions. The IRS requires that you begin taking distributions by April 1 of the year following your 72nd birthday. However, you may delay taking RMDs from your 401 if youre still working and own less than 5% of the company that sponsors the plan.
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Contact Your Current Plan Administrator And New Plan Administrator
The easiest 401 rollover option is to get your old plan administrator to transfer your balance directly to your new account. This is called a direct 401 rollover, and it frees you from having to worry about tax consequences or early withdrawal penalties.
Speak with your new plan provider about getting an account number, then provide the information to your current 401 administrator. Theyll take care of the rest.
Be aware that not every plan administrator will perform a direct 401 rollover. In this case, the plan administrator cuts you a check for the balance, and its up to you to send the funds to your new 401 plan provider. You have just 60 days to redeposit the balance in your new plan. Otherwise its treated as an early withdrawal that incurs a penalty and income tax liabilities.
Drawbacks Of Rolling Over Into A New 401
Like keeping your money in your previous employers plan, rolling over into a new 401 limits your control of your money and poses some other potential drawbacks.
Higher fees: After comparing fees and expenses, you may find that the new plan is more expensive than the previous one. Remember, even a margin of a percentage point can drastically eat into your earnings over a long period of time.
Less diversification: The investments offered in the new plan may be less varied than your old plan or potential IRA investments. And because the account will be managed by someone else, you wont have much of a say in how your money is invested.
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