Using Retirement Savings To Fund An Annuity
Say youre interested in using your retirement funds to buy an annuity. Should you withdraw the funds from your retirement account, pay the taxes and then buy the annuity? Or can you just roll over the funds directly into the annuity, continuing to avoid taxes until you receive the income stream payments?
In most cases, the Internal Revenue Service allows qualified funds to be transferred into, or out of, qualified annuities.
Direct rollovers occur when qualified funds move from one trustee to another trustee without touching the owner. Under these circumstances, direct transfers are tax-free. Direct transfers are commonly done by mailing or wiring funds directly to the new plan provider, but on some occasions the old plan provider may mail the check directly to you, payable to the new plan provider. This still counts as a tax-free direct transfer.
Indirect rollovers, however, are more complicated and have significant tax consequences if not executed correctly. Indirect rollovers occur when the participant takes constructive receipt of the funds. In order to remain tax-free, the funds must be rolled over within 60 days of distribution. Otherwise, the distribution is income taxable and may also be subject to the penalty for withdrawing funds prior to age 59½.
The advice here is simple: whenever possible use direct transfers.
To Roll Over Or Not To Rollover
When you leave your job, you should decide what to do with your retirement savings. You can decide to rollover the 401 to another retirement account or leave it in the old employerâs plan. Usually, you must have a 401 balance of at least $1000 to leave the retirement savings in your former employerâs 401 plan. However, you will no longer contribute to the old employerâs plan, and your retirement savings will continue accumulating 401 fees.
If you have built a sizable 401 balance over the years, you should consider rolling over to an IRA. An IRA offers a wider variety of investments, which allows you to pick investments with the best returns and low fees. You also have the option of opening a Roth IRA, which allows you to pay taxes now, and take tax-free distributions in retirement.
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Moving Money From A Retirement Plan Is Only One Of The 8 Common Ways To Free Up Money To Fund A Bank On Yourself Plan
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*Consider all available options, which include remaining with your current retirement plan, rolling over into a new employer’s plan or IRA, or cashing out the account value. When deciding between an employer-sponsored plan and IRA, there may be important differences to consider – such as range of investment options, fees and expenses, availability of services, and distribution rules . Depending on your plan’s investment options, in some cases, the investment management fees associated with your plan’s investment options may be lower than similar investment options offered outside the plan.
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3Generally, as long as you’ve held the account at least 5 years and you’re age 59½ or older.
Roll It Over To An Ira
This option makes sense if you want to roll over your 401 and you want to avoid a taxable event. If you have an existing IRA, you may be able to consolidate all of your IRAs in one place. And an IRA gives you many investment options, including low-cost mutual funds and ETFs.
There are plenty of mutual fund companies and brokerages that offer no-load mutual funds and commission-free ETFs, says Greg McBride, CFA, Bankrate chief financial analyst.
You also want to just make sure that youre satisfying any account minimums so that you dont get dinged for an account maintenance fee for having a low balance, McBride says. Index funds will have the lowest expense ratios. So theres a way that you can really cut out a lot of the unnecessary fees.
Check with your IRA institution first to ensure that it will accept the kind of rollover that you would like to make.
The letter of the law says it is OK . But in practice, your 401 plan may not allow it, says Michael Landsberg, CPA/PFS, member of the American Institute of CPAs Personal Financial Planning Executive Committee.
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Leveling The Playing Field
Because they aren’t offered through employers, IRAs are not subject to the type of nondiscrimination testing that applies to 401 contributions.
However, IRAs were developed to encourage the average worker to save for retirement, not as another tax shelter for the rich. To prevent unfair benefit to the wealthy, the contributions to a traditional IRA that are tax-deductible may be reduced if the account holder or spouse is covered by an employer-sponsored plan, or if their combined income is above a certain amount.
Also, Roth IRA contributions are phased out for people whose modified adjusted gross income is above a certain level.
Reduced contributions to Roth IRAs are allowed for:
- Single filers with MAGIs between $125,000 and $140,000 for 2021 .
Roth IRA contributions are not allowed for:
- Single filers earning more than $140,000 in 2021 .
Roll Over Your 401 To A Traditional Ira Then Convert It To A Roth Ira
Contributions to your 401 plan were pre-tax. This means your employer deducted them from your taxable salary when reporting your income to the IRS. Same goes for any employer matches. So you have yet to pay taxes on any contributions and on any accrued earnings.
Traditional IRAs are also tax-advantaged. The difference, of course, is that individuals rather than employers send their contributions to their financial institutions and claim the deduction when filing their taxes. So like 401 balances, the money in an IRA is tax-deferred. You wont owe taxes on it until you retire and start taking distributions.
This is why rolling over your 401 to a traditional IRA is fairly straightforward. Its an apples-to-apples transaction.
No doubt, there are significant advantages to moving your 401 money to a Roth IRA. But, as noted earlier, it will be a taxable event. You will owe taxes not only on your contributions and your companys contributions if it has a matching program, but also on your earnings, which include capital gains and dividends. This bump in income could boost you to a much higher income bracket so that you are paying more tax than if you left the money in a traditional IRA and paid taxes as you made withdrawals in retirement.
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Can You Invest In Real Estate Through Your 401k
If you have a 401k plan through your employer, the answer is probably no — at least not directly. I have yet to find an employer-sponsored retirement plan that allows participants to buy investment properties or participate in crowdfunded real estate investments.
The only possibility of even putting money to work in real estate indirectly in an employer-sponsored 401k would be if there’s a real estate investment fund on the plan’s menu of investment options. For example, the Vanguard Real Estate Index Fund might be one of the funds offered by your plan.
Should You Do A Partial 401 Rollover
It really depends on your financial situation and whether or not there is an advantage to leaving part of your money invested in the current 401. Just know that it is possible to move a portion of your money to a rollover IRA while keeping the rest of your money in the existing 401 plan.
Joshua Holt A practicing private equity M& A lawyer and the creator of Biglaw Investor, Josh couldnt find a place where lawyers were talking about money, so he created it himself. He knows that the Bogleheads forum is a great resource for tax questions and is always looking for honest advisors that provide good advice for a fair price.
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What Is A Roth 401
The Roth 401 is a workplace retirement savings account that combines the convenience of a traditional 401 with all the benefits of a Roth IRA. Its the best of both worlds!
There are some similarities between traditional 401 and Roth 401 options. Companies can offer a match through either, and these options also have a $20,500 contribution limit in 2022. But thats where the similarities end.
The biggest difference between a traditional 401 and a Roth 401 is how your contributions are taxed. When you put money into a traditional 401, youre using pretax dollars. That means the money goes into your 401 before you pay taxes on it. Those taxes are then deferred until you make withdrawals from your 401 in retirement.
On the other hand, your contributions to a Roth 401 are made with after-tax dollars, meaning you invest that money in your Roth 401 after you pay taxes on it. Its a little more expensive on the front end, but its worth it. Why? Because you get the benefit of tax-free growth on your contributions. So when you start withdrawing money in retirement, you wont have to pay a single penny in taxes.
Whenever you can make tax-free growth part of your investment strategy, do it!
There is one important thing to remember about the Roth 401: Only your contributions grow tax-free. If your company offers a match, youll have to pay taxes on retirement income from the match side of the account.
When Leaving Your Job You Can Typically Cash Out Your 401 Or Roll It Over Into A Different Retirement Account Certain Options Can Make You Much Richer
Both a 401 and IRA are tax-advantaged retirement accounts, but they work differently. 401s are sponsored by employers and often offer limited investment options. IRAs aren’t linked to employment. They can be opened with any brokerage firm or other financial institutions and have a wider variety of investment selections, but require more hands-on management.
Because 401s are offered through employers, you’ll need to determine what to do with yours when you leave your job. Your options include:
- Leave it invested
- Rollover to a new 401
- Rollover to an IRA
There are plenty of pros and cons to these options, but let’s take a close look at when rolling your workplace 401 into an IRA may make sense for you.
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Next Steps To Consider
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Recently enacted legislation made a number of changes to the rules regarding defined contribution, defined benefit, and/or individual retirement plans and 529 plans. Information herein may refer to or be based on certain rules in effect prior to this legislation and current rules may differ. As always, before making any decisions about your retirement planning or withdrawals, you should consult with your personal tax advisor.
The change in the RMD age requirement from 70½ to 72 only applies to individuals who turn 70½ on or after January 1, 2020. Please speak with your tax advisor regarding the impact of this change on future RMDs.
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided the 5-year aging requirement has been satisfied and one of the following conditions is met: age 59½ or older, disability, qualified first-time home purchase, or death.
Be sure to consider all your available options and the applicable fees and features of each before moving your retirement assets.
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How To Do A Rollover
The mechanics of a rollover from a 401 plan are fairly straightforward. Your first step is to contact your companys plan administrator, explain exactly what you want to do, and get the necessary forms to do it.
Then, open the new Roth IRA through a bank, a broker, or an online discount brokerage.
Finally, use the forms supplied by your plan administrator to request a direct rollover, also known as a trustee-to-trustee rollover. Your plan administrator will send the money directly to the IRA that you opened at a bank or brokerage.
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Can You Still Contribute To A 401k After Retirement
If you want to keep contributing to your retirement savings but cannot contribute to your 401 after retiring from your job at that company, you can elect to roll over your account into an IRA. Previously, you could contribute to a Roth IRA indefinitely, but could not contribute to a traditional IRA after age 70½.
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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.
What A Rollover Can Cost You
Before you pull the trigger on an IRA rollover, though, you need to understand the other disadvantages, which are numerous:
You may not hear about these disadvantages if you turn to a financial services firm for advice. Three years ago the U.S. Government Accountability Office mystery-shopped financial service call centers and found one-third immediately launched into a pitch about why rollovers were the right choice.
Within 10 to 15 seconds, you have the call center representative trying to convince the caller without any knowledge about the financial situation, Hauptman says. You can hear some of the pitches on this video.
There’s a reason for those sales pitches: IRA rollovers arent just big business for Wall Street theyre huge business. Most of the $7.6 trillion held in IRAs comes from rollovers, according to the Investment Company Institute. The amount rolled into IRAs in 2013 was nearly 13 times the amount contributed directly, according to the Employee Benefits Research Institute, and an earlier ICI study found that more than 90% of funds going into IRAs came from rollovers. More than $400 billion is rolling into IRAs from company plans every year as the baby boomers begin to retire, according to research firm Cerulli Associates.
If you need help managing financial goals like retirement, you might turn to a financial advisor. A fee-only advisor who follows the fiduciary standard of putting your interest first is a good choice.
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