Should You Roll Over Your 401 To An Ira
Millions of Americans have changed jobs over the past year. And while career change can be exciting, it can also raise many questions, including: Should I roll over my 401 plan into an IRA?
Retirement plans like 401s, 403s and IRAs qualify for tax benefits. That makes them an appealing way to save for retirement. But it also means there are rules about how you can use them. When you leave a job, many times you can leave retirement funds in your former employerâs plan. But you could also opt for a rollover, which allows you to move the funds while retaining their tax benefits.
Sometimes a rollover is beneficial because it allows you to consolidate retirement accounts, keeping everything in one place. But there are a number of other pros and cons you may want to consider before rolling 401 funds into an IRA.
These tips can offer some guidelines to help you determine if rolling over your 401 to an IRA makes sense for you.
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.
How To Transfer A Traditional Ira Into A 401
If youve weighed the choices and decided youd like to combine retirement plan balances inside your 401 and your 401 plan provider is ready and willing to take those IRA assets there are steps you need to take to do it right.
First, know that you cant roll a Roth IRA into a 401 not even into a Roth 401. Were specifically talking about pretax money in a traditional IRA here.
As with a 401 rollover, the easiest way to roll a traditional IRA into a 401 is to request a direct transfer, which moves the money from your IRA into your 401 without it ever touching your hands. Contact your 401 plan administrator for instructions on how to do this following its guidance will allow you to avoid taxes and penalties.
About the author:Arielle O’Shea is a NerdWallet authority on retirement and investing, with appearances on the “Today” Show, “NBC Nightly News” and other national media. Read more
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Roll Over Your 401 To A Roth Ira
If you’re transitioning to a new job or heading into retirement, rolling over your 401 to a Roth IRA can help you continue to save for retirement while letting any earnings grow tax-free.2
- You can roll Roth 401 contributions and earnings directly into a Roth IRA tax-free.2
- Any additional contributions and earnings can grow tax-free.2
- You are not required to take RMDs.
- You may have more investment choices than what was available in your former employer’s 401.
- Your Roth IRA provider may offer additional services, such as investing tools and guidance.
- You can consolidate multiple retirement accounts into a single Roth IRA to simplify management.
- You can’t borrow against a Roth IRA as you can with a 401.
- Any Traditional 401 assets that are rolled into a Roth IRA are subject to taxes at the time of conversion.
- You may pay annual fees or other fees for maintaining your Roth IRA at some companies, or you may face higher investing fees, pricing, and expenses than you did with your 401.
- Some investments offered in a 401 plan may not be offered in a Roth IRA.
- Your IRA assets are generally protected from creditors only in the case of bankruptcy.
- Rolling over company stock may have negative tax implications.
Which One Do You Choose
Where are you now financially compared to where you think youll be when you tap into the funds? Answering this question may help you decide which rollover to use. If youre in a high tax bracket now and expect to need the funds before five years, a Roth IRA may not make sense. Youll pay a high tax bill upfront and then lose the anticipated benefit from tax-free growth that wont materialize.
If youre in a modest tax bracket now but expect to be in a higher one in the future, the tax cost now may be small compared with the tax savings down the road. That is, assuming you can afford to pay taxes on the rollover now.
Bear in mind that all withdrawals from a traditional IRA are subject to regular income tax plus a penalty if youre under 59½. Withdrawals from a Roth IRA of after-tax contributions are never taxed. Youll only be taxed if you withdraw earnings on the contributions before you’ve held the account for five years. These may be subject to a 10% penalty as well if youre under 59½ and dont qualify for a penalty exception.
Its not all or nothing, though. You can split your distribution between a traditional and Roth IRA, assuming the 401 plan administrator permits it. You can choose any split that works for you, such as 75% to a traditional IRA and 25% to a Roth IRA. You can also leave some assets in the plan.
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Benefits For Early Retirement
If you ever need to withdraw your funds before reaching 59, then you should keep your money in the 401 plan. This is one of the key reasons not to rollover 401 to an IRA. With a 401 plan, you can access your funds at the age of 55. For early withdrawal on an IRA, youll have to pay a 10 percent penalty.
You may also be allowed to make withdrawals from your 401 several times annually after you leave your company. Note that the employer may make rules about the number of times that individuals within this age group can make withdrawals.
However, if you rollover 401 into an IRA, youll not be able to enjoy this privilege. To access your funds without incurring an early withdrawal penalty, youll have to wait until 59 ½ years of age.
Why You Should Move Your 401 Into An Ira
The 401 is a blessing for many people, as it allows them to build wealth over time using dollar-cost averaging. Still, sometimes it makes more sense to channel some of that money from the employer-based account into your own individual retirement account. The ever-astute Rick Kahler, the founder of Kahler Financial Group, in Rapid City, S.D., tells us why:
Larry Light: Why and when should you move your 401 into an IRA?
Rick Kahler: If your employer offers a 401 or other retirement plan, contributing to that plan is a foundation of your retirement savings. However, as you approach retirement age, you might consider moving some of your retirement funds out of your employer’s plan and into an IRA at a custodian like TD Ameritrade or Fidelity.
Such a rollover is often done when you leave an employer, though many employers give you the option of keeping your retirement account with them. What isnt popularly understood is that you also can do a rollover while you’re still employed, as long as you are over 59½.
Light: Why do this?
Kahler: One reason to consider leaving your employers plan is that most of them have higher overall fees than an IRA, especially if you choose from low-cost index mutual funds or exchange traded funds from a company like Vanguard or Dimensional Fund Advisors. Its not uncommon to save up to 1% annually by making a rollover into these mutual funds.
Light: What about withdrawing the money to live on? Is there a difference?
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Dont Roll Over Employer Stock
There is one big exception to all of this. If you hold your company stock in your 401, it may make sense notto roll over this portion of the account. The reason is net unrealized appreciation , which is the difference between the value of the stock when it went into your account and its value when you take the distribution.
Youre only taxed on the NUA when you take a distribution of the stock and opt notto defer the NUA. By paying tax on the NUA now, it becomes your tax basis in the stock, so when you sell it , your taxable gain is the increase over this amount.
Any increase in value over the NUA becomes a capital gain. You can even sell the stock immediately and get capital gains treatment. The usual more-than-one-year holding period requirement for capital gain treatment does not apply if you dont defer tax on the NUA when the stock is distributed to you.
In contrast, if you roll over the stock to a traditional IRA, you wont pay tax on the NUA now, but all of the stocks value to date, plus appreciation, will be treated as ordinary income when distributions are taken.
Lower Investment Fees And Costs
Another reason you should roll over your 401 to an IRA is to have better cost control. A 401 plan has a set fund structure that can potentially carry higher than average fees, eating into your portfolios return. Furthermore, plan administration and consultant fees are in addition to the plans total cost.
Rolling your 401 into an IRA would allow you to take advantage of dirt-cheap mutual funds or even trade individual stocks and bonds for free. You would also avoid administrative costs, significantly lowering your portfolios fees, which can add up over your career.
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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.
Avoid These Costly Mistakes When Rolling Over A 401 To An Ira
- Before you move your money, be sure you know the rules that differ between 401 plans and IRAs.
- If the rollover process is done incorrectly, it could be considered a distribution, which would make it subject to taxation and, possibly, an early withdrawal penalty.
- There are also some situations that call for caution before embarking on the rollover.
So you’ve left your job and want to move assets from your workplace savings plan to an individual retirement account.
You may want to pause before doing the rollover. If you’re not careful, you could make costly errors or lock yourself into a move that can’t be easily undone.
Both 401 plans and IRAs have the common purpose of letting you put away tax-advantaged savings for retirement. However, there are some rules that differ between the two. Even the rollover process itself can come with snags if you’re not careful.
More from Smart Tax Planning:
Here are some things to be aware of before initiating a rollover. These apply to traditional 401 plans and IRAs, whose contributions are generally made pre-tax.
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Rolling Your Old 401 Over To A New Employer
To keep your money in one place, you may want to transfer assets from your old 401 to your new employers 401 plan. Doing this will make it easier to see how your assets are performing and make it easier to communicate with your employer about your retirement account.
To roll over from one 401 to another, contact the plan administrator at your old job and ask them if they can do a direct rollover. These two words “direct rollover” are important: They mean the 401 plan cuts a check directly to your new 401 account, not to you personally.
Generally, there aren’t any tax penalties associated with a 401 rollover, as long as the money goes straight from the old account to the new account.
Although this route may help you stay organized with fewer accounts to keep track of, make sure your new 401 has investment options that are right for you and that you aren’t incurring higher account fees.
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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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.
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.
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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Its Your Money And Your Choice
When it comes to what to do, there are advantages and disadvantages to all options so theres no one right answer for all. You need to review your options and choose whats best for you and your retirement. Retirement savings is one of the most important and long-lasting investment decisions youll ever make. If youre not sure what to do, you always have the option of talking to an advisor. Whether you need a bit of advice or a comprehensive financial plan, a Certified Financial Planner can help guide you in the right direction.
Option : Roll It Into Your New 401
If your new employer offers a 401, you can possibly roll your old account into the new one. You may be required to be with the company for a certain amount of time before youre eligible to participate in their plan.
You can choose to do a Direct Rollover, whereby the administrator of your old plan transfers your account balance directly into the new plan. This only requires some paperwork.
Or, you can choose an Indirect Rollover. With this option, 20% of your account balance is withheld by the IRS as federal income tax in addition to any applicable state taxes. The balance of your old account is given to you as a check to deposit into your new 401 within 60 days. There is one catch, though. Youll need to deposit the entire amount of your old account into your new account, even the amount withheld for taxes. That means using personal cash to cover the difference and waiting until tax season to be reimbursed by the government.