When You Leave A Job You Don’t Have To Leave Your 401 Behind
Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
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When you change jobs, you usually have four options for your 401 plan account. You can cash it out , leave it where it is , transfer it into your new employer’s 401 plan , or roll it over into an individual retirement account . For most people, rolling over a 401 cousin for those in the public or nonprofit sector) is the best choice. This article explains why and how to go about it.
Rollover To Ira: How To Do It In 4 Steps
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A 401 rollover is a transfer of money from an old 401 to an individual retirement account or another 401. You’d most likely need to do a rollover when you leave a new job to start a new one, and if you’re in this situation, you likely have a few options, such as rolling your old 401 into your new workplace 401, or cashing it out.
This article focuses on rolling a 401 over to an IRA, which is a great way to consolidate your retirement accounts and keep an eye on your investments.
Direct Vs Indirect Rollovers
A direct rollover is when your money is transferred electronically from one account to another, or the plan administrator may cut you a check made out to your account, which you deposit. The direct rollover is the best approach.
In an indirect rollover, the funds come to you to re-deposit. If you take the money in cash instead of transferring it directly to the new account, you have only 60 days to deposit the funds into a new plan. If you miss the deadline, you will be subject to withholding taxes and penalties. Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.
Because of this deadline, direct rollovers are strongly recommended. In many cases, you can shift assets directly from one custodian to another, without selling anything. This is known as a trustee-to-trustee or in-kind transfer.
Otherwise, the IRS makes your previous employer withhold 20% of your funds if you receive a check made out to you. Its important to note that if you have the check made out directly to you, taxes will be withheld, and youll need to come up with other funds to roll over the full amount of your distribution within 60 days.
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Net Unrealized Appreciation And Company Stock In A 401
If you have company stock in a 401, it could save you significant money on taxes to transfer those shares into a taxable brokerage account to take advantage of net unrealized appreciation, or NUA. NUA is the difference between what you paid for company stock in a 401 and its value now.
For example, if you paid $20,000 for company stock and its now worth $100,000, the NUA is $80,000.
The benefit of the NUA approach is that it helps you avoid paying ordinary income tax on these distributions of your own companys stock from your retirement account. That can be up to 37 percent, which is now the highest tax bracket, says Landsberg.
Instead, youll enjoy capital gains tax treatment, which even at the highest tax bracket is only 20 percent, on any appreciation. High earners, however, will be subject to a bonus 3.8 percent net investment income tax. And an NUA may be subject to a 10 percent early withdrawal tax if you move funds prior to age 59 1/2.
Landsberg says NUA makes the most sense when the difference in tax rates is higher.
Net unrealized appreciation is a very powerful tool, if used correctly, Landsberg says. So you can get creative and potentially have a pretty nice windfall if you use the NUA rules correctly.
What If I Dont Have Any Information On My 401
Thats okay. If youre doing this on your own, we recommend emailing your former HR contact to begin and just asking them who the 401 provider is on the plan. Thats something they should know because the 401 provider is chosen by your former employer.
Search our 401 provider database using your employer name! Weve built a tool to help you find your old 401 instantly by typing in the name of your former employer.
Which Types Of Distributions Can I Roll Over
IRAs: You can roll over all or part of any distribution from your IRA except:
Retirement plans: You can roll over all or part of any distribution of your retirement plan account except:
Distributions that can be rolled over are called “eligible rollover distributions.” Of course, to get a distribution from a retirement plan, you have to meet the plans conditions for a distribution, such as termination of employment.
Begin The Rollover Process
Youll have to fill out paperwork to conduct your rollover and it may require some back-and-forth conversations with your providers. You have several options to actually move the money from the old provider to the new one, but your best option is a direct rollover.
In a direct rollover, the funds are sent straight from your 401 into your new account without you touching the funds. Its important that you specify a direct rollover so that you dont have the check made payable to you. You could trigger a mandatory 20 percent withholding for taxes, and the IRS charges a 10 percent bonus penalty on withdrawals made before age 59 1/2.
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Why Do A 401 Rollover
Sometimes it makes sense to leave your money in your old employers 401 plan. In fact, if you have over $5,000 in the account, your employer has to give you the option to keep the money in the account.
More likely than not, while you were working for them, they were also paying for the administrative fees associated with the account upkeep. They may no longer be willing to do that, even if you keep your money in their plan.
If you have anywhere from $1,000-$5,000 in your account, your employer is legally obligated to send you a letter and document in writing the options that you have. It is then up to you to inform them what you want to do. If you choose not to respond, they can roll the money over to an IRA on your behalf which is called an involuntary cash-out.
For accounts with $1,000 or less, many employers will write you a check. Just be sure to deposit that check in a new 401 or IRA within 60 days to avoid the tax penalty.
Reasons You May Want To Wait To Roll Over Your 401
- Temporary ban on contributions. Some plan sponsors impose a temporary ban on further 401 contributions for employees who withdraw funds before leaving the company. You’ll want to determine if the gap in contributions will significantly impact your retirement savings.
- Early retirement. Most 401s allow penalty-free withdrawals after age 55 for early retirees. With an IRA, you must wait until 59 ½ to avoid paying a 10% penalty.
- Increased fees. IRA investors may pay more fees than they would in employer-sponsored plans. One reason: The range of more sophisticated investment options you may choose can be more expensive than 401 investments. Your advisor can help identify what extra cost a rollover may incur and if the benefits of the rollover justify those additional costs.
- Can take loans out. Your 401 may permit you to take out a loan from the account, but this is typically only for active employees. And you may have to pay in full any outstanding loan balances when you leave the company. You cannot take loans from IRAs.
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Keep Your 401 With Your Previous Employer
In this instance, you wont change a thing. Just make sure that you actively monitor your investments in the plan for performance and remain aware of any significant changes that occur.
If you really like your current investment options and are paying low fees on the investments, this might be the right choice for you.
Finish Any Last Transfer Steps
Chances are that by this stage youre done, and your 401 provider has initiated the process of rolling over your 401 into your new IRA. If so, congrats on getting to the finish line!
But there can sometimes be a small extra step at this stage. Thats because some 401 providers will only distribute your 401 funds to you, not to your new IRA provider. If thats the case then theyll send a check with your money to your mailing address. Its then up to you to forward on that check to your new IRA provider using the mailing details that youd previously looked up.
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Decide What Kind Of Account You Want
Your first decision is what kind of account youre rolling over your money to, and that decision depends a lot on the options available to you and whether you want to invest yourself.
When youre thinking about a rollover, you have two big options: move it to your current 401 or move it into an IRA. As youre trying to decide, ask yourself the following questions:
- Do you want to invest the money yourself or would you rather have someone do it for you? If you want to do it yourself, an IRA may be a good option. But even if you want someone to do it for you, you may want to check out an IRA at a robo-advisor, which can design a portfolio for your needs. But do-it-for-me investors may also prefer to make a rollover into your current employers 401 plan.
- Does your old 401 have low-cost investment options with potentially attractive returns, and does your current 401 offer similar or better options? If youre thinking about a rollover to your current 401 plan, youll want to ensure its a better fit than your old plan. If its not, then a rollover into an IRA could make a lot of sense, since youll be able to invest in anything that trades in the market. Otherwise, maybe it makes sense to keep your old 401.
- Does your current 401 plan offer access to financial planners to help you invest? If so, it could make sense to roll your old 401 into your new 401. If you move money to an IRA, youll have to manage it completely and pick investments or hire someone to do so.
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.
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Decide Where To Open Your New Ira
When opening an IRA, most people will look towards a brokerage, and for obvious reasons. 401 accounts are notorious for their relatively limited investment selections. But by rolling your funds into an IRA at a brokerage, youll get to choose from a significantly larger pool of potential investments. In fact, many offer some combination of stocks, bonds, exchange-traded funds , mutual funds, options and more.
Managing your own retirement funds takes a lot of time and energy, but a financial advisor can do it for you. Many financial advisors specialize in retirement planning and investing, which is exactly the combination youll need. If you go this route, your advisor will manage your investments in an IRA according to your needs and current savings situation.
If you prefer an even more hands-off approach to investing, a robo-advisor could be a good option. When you open an IRA with a robo-advisor, an asset allocation profile will be created for you based on your age, risk tolerance and proximity to retirement. The robo-advisor will then invest and manage your assets for you according to this plan.
Regardless of which way you go, make sure you understand any account, investment or advisory fees you may incur. An overbearing fee structure can have an extremely negative effect on your portfolio, so keep an eye out for this.
What Is Rollover Equity When You Sell Your Business
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So youve finally decided to sell your business. Thats an important decision, but only the first of many decisions you will need to make before you finish the sales journey. Other important decisions include building the right deal team, identifying the right buyer and deciding how much rollover equity you want to invest. What is rollover equity? It is the amount of money that a business seller is expected to invest into the future equity of the company.
The class of buyers that are most active in todays market are private equity firms. Private equity firms typically partner with business sellers and their management teams to run the business going forward, usually during an ownership period of four to seven years. These private equity firms want to ensure alignment of incentives so that the seller has a vested stake in the future success of the business. The minimum rollover equity most private equity firms expect is a 20% stake. But that does not mean that the seller must leave behind 20% of the proceeds. Because most acquisitions are funded by a combination of debt and equity, this leverage increases cash proceeds and reduces the amount needed to acquire a 20% stake.
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How To Roll Over A 401
If you change employers and your new employer has a 401 plan for which you are eligible, you can roll over your funds into the new plan. It is preferable to do this as a direct transfer of funds rather than requesting a check, because if you take longer than 60 days to complete the rollover, the IRS will treat it as an early withdrawal subject to taxes and penalties.
When you retire, you will need to decide if you want to keep your money in your former employers 401 or roll it over into an Individual Retirement Account . Its important to weigh this decision carefully, as there can be pros and cons to each option, Comfort says. An IRA may offer you more varied and more flexible investment options, including access to alternative classes that arent generally well-represented in 401 plans. If you worked for a big company, though, it might be worth staying with that 401, where youre likely to have access to low-cost investment options.
If you worked for multiple employers over the course of your career and kept each respective retirement account where it was, rolling them all over into a single IRA could consolidate your financial planning and give you a better snapshot of your financial health.
Rolling Over Your 401 To A Traditional Ira Vs A Roth Ira
You have the option of rolling your 401 into either a traditional IRA or a Roth IRA. One isnt better than the other, and ultimately its up to you and your investment goals.
You do have to worry about a few things, though, and the major difference is this: Roth IRAs require after-tax contributions. If youre rolling over money from a traditional 401, then you havent paid taxes on that money as it came out of your salary before you got your paycheck. As a result, rolling your traditional 401 balance over to a Roth IRA will require you to pay income taxes on the entire balance in the year that you do the rollover. This could mean thousands of dollars in taxes. So just be cautious of this.
However, rolling a traditional 401 into a traditional IRA is easier, since both contain pre-tax dollars. You dont have to worry about triggering a taxable event.
On the same note, a Roth 401 and Roth IRA are both funded with after-tax dollars, meaning rolling one into the other wouldnt require a tax payment.
Paying income taxes by rolling a traditional 401 into a Roth IRA isnt necessarily a reason not to do it: Roth IRAs can be a powerful retirement savings tool, and some investors may prefer to pay the tax bill now for the benefit of withdrawing the money tax-free during retirement.
But whatever decision you make, its important that you understand the consequences and have your budget ready.
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