Make The Best Decision For You
When it comes to deciding what to do with an old 401, there may be factors that could be unique to your situation. That means the best choice will be different for everyone. One thing to remember is that the rules among retirement plans vary so it’s important to find out the rules your former employer has as well as the rules at your new employer.
Do also compare the fees and expenses associated with the accounts you’re considering. If you find it confusing or overwhelming, speak with a financial professional to help with the decision.
Transferring Your 401 To Your Bank Account
You can also skip the IRA and just transfer your 401 savings to a bank account. For example, you might prefer to move funds directly to a checking or savings account with your bank or credit union. Thats typically an option when you stop working, but be aware that moving money to your checking or savings account may be considered a taxable distribution. As a result, you could owe income taxes, additional penalty taxes, and other complications could arise.
IRA first? If you need to spend all of the money soon, transferring from your 401 to a bank account could make sense. But theres another option: Move the funds to an IRA, and then transfer only what you need to your bank account. The transfer to an IRA is generally not a taxable event, and banks often offer IRAs, although the investment options may be limited. If you only need to spend a portion of your savings, you can leave the rest of your retirement money in the IRA, and you only pay taxes on the amount you distribute .
Again, moving funds directly to a checking or savings account typically means you pay 20% mandatory tax withholding. That might be more than you need or want. Most IRAs, even if theyre not at your bank, allow you to establish an electronic link and transfer funds to your bank easily.
When To Roll Over Your 401 To An Ira
Rolling over your 401 to an IRA is possible only if you’re leaving your current employer or your employer is discontinuing your 401 plan. It is an alternative to:
- Leave your money invested in your existing 401
- Rollover to your new employer’s 401
- Withdrawal from your 401, which would trigger a 10% penalty if you aren’t 59 1/2 or older
A rollover or IRA) does not have tax consequences. This would not be the case if you do a rollover to a Roth IRA.
Rolling over a 401 to an IRA provides you with the opportunity to choose which brokerage you want to hold your retirement funds. It may be the right choice if:
- Your new employer doesn’t offer a 401 plan
- You cannot keep your money invested in your current workplace plan because your plan is being discontinued or your 401 administration won’t allow you to stay invested for some other reason
- Your new employer’s 401 plan charges high fees, offers limited investments, or has other drawbacks
- You’d prefer a wider choice of investment options
However, there are some downsides to consider:
- While 401 loans allow you to borrow against your retirement funds, no such option exists with an IRA.
- Transferring company stock can be complicated account, read up on an “NUA strategy” that could save you a lot of money.)
If these downsides aren’t deal breakers for you, the next step is figuring out how to roll over your 401 to an IRA.
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Rolling Over To A New 401
If your new employer allows immediate rollovers into its 401 plan, this move has its merits. You may be used to the ease of having a plan administrator manage your money and to the discipline of automatic payroll contributions. You can also contribute a lot more annually to a 401 than you can to an IRA.
Another reason to take this step: If you plan to continue to work after age 72, you should be able to delay taking RMDs on funds that are in your current employer’s 401 plan, including that roll over money from your previous account. Remember that RMDs began at 70½ prior to the new law.
The benefits should be similar to keeping your 401 with your previous employer. The difference is that you will be able to make further investments in the new plan and receive company matches as long as you remain in your new job.
But you should make sure your new plan is excellent. If the investment options are limited or have high fees, or there’s no company match, the new 401 may not be the best move.
If your new employer is more of a young, entrepreneurial outfit, the company may offer a Simplified Employee Pension IRA or SIMPLE IRAqualified workplace plans that are geared toward small businesses plans). The Internal Revenue Service does allow rollovers of 401s to these, but there may be waiting periods and other conditions.
Benefits To Rolling Over To A New 401
Rolling over an old 401 to a new one has several advantages:
- Potentially more cost effective: Each 401 is different. Compare costs between your old plan and the new one. In many cases, your new plan may be more cost effective.
- Easier management: Its generally easier to manage one account vs. multiple accounts. By rolling over your old retirement plan into your new employers 401 plan, you can keep all of the information in one place. A recent study by Capitalize estimated that there were 24.3 million forgotten 401 accounts holding $1.35 trillion in assets as of May 2021.
- Advantages of the rule of 55: If you retire or lose your job when youre 55 years old, you can take funds out of your retirement fund without suffering any penalties. This is called the rule of 55, and it only applies to your latest employer. Funds from an earlier employers plan are not eligible.
- Continued growth can compound:By rolling over your old 401 into a new one, you can ensure that youll continue earning interest on those funds. Over time, compounding interest will help your retirement account grow.
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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.
How Do I Complete A Rollover
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What Is A Rollover Ira
A rollover IRA is identical to a Traditional IRAor Roth IRA in the case of rolling over Roth 401 fundsexcept that the source of the money is not annual contributions. Instead, the money that goes into a rollover IRA is money from a previous retirement plan, such as a 401 plan. If you do not already have an IRA, you may open one for the purpose of rolling over your 401 funds without making any additional annual contributions. On the other hand, if you do have an IRA, you are permitted to roll over your 401 into that existing contributory IRA account.
It is important to note, however, that you may not combine traditional IRA and 401 funds with Roth IRA and Roth 401 funds.
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Option : Roll Over The Money Into Your New Employers Plan
Rolling your money over to your new 401 plan has some benefits. It simplifies your investments by putting them in one place. And you also have higher contribution limits with a 401 than you would with an IRAwhich means you can save more!
But there are lots of rules and restrictions for rolling money over into your new employers plan, so its usually not your best bet. Plus, your new 401 plan probably only has a handful of investing options to choose from too. And if youre feeling iffy about those options, why put all your retirement savings there? Which brings us to . . .
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Advantages Of Rolling Over Your 401
1. You can consolidate your 401 accounts
Especially if you change jobs often, you might find yourself with many 401 accounts scattered around. The more accounts you have, the harder it may be to actively make decisions. By having your retirement funds all in one place, you may be able to manage them more carefully.
2. Youll have more investment choices in an IRA
With your 401, you are restricted to the investment and account options that are offered in that plan. An IRA can give you a more diverse option of items to invest in. In an IRA you may be able to invest in individual stocks, bonds or other vehicles that may not be available in your 401.
You cant add to the 401 at your previous employer. But if you roll this money over into a traditional IRA, you can add to that traditional IRA over time, up to the annual maximum. Youll have to follow the IRA contribution guidelines.
3. Youll have the choice to bring the account anywhere youd like
With an IRA, you can take your money with you to any advisor, if you already have a financial advisor or financial planner that you work with, for example. Or maybe you already have a brokerage where some of your money is being managed, and you want all your funds there.
Rolling Over Your 401 Into An Ira Account Comes With Many Benefits
When you change jobs, you generally have four options for your 401 plan. One of the best options is doing a 401 rollover to an individual retirement account . The other options include cashing it outand pay taxes and a withdrawal penalty, leave it where it isif your ex-employer allows this, or transfer it into your new employer’s 401 planif one exists. For most people, rolling over a 401 for those in the public or nonprofit sector) is the best choice. This article explains why and how to go about it.
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Reasons To Avoid A 401 Rollover
There are some cases when it doesnât make sense to roll your 401 into another account:
⢠IRAs are less protected. If you end up declaring bankruptcy later, a 401 offers more protection from creditors than an IRA.
⢠Higher fees. Depending on the situation you could end up with higher fees when you roll an old 401 into a new 401. Check the fees associated with the new account before you move your money.
⢠Limited investment choices. A new employerâs 401 might have more limited investment choices. If thatâs the case, you might want to stick with your existing 401 because the assets work better for your situation.
⢠A 401 gives you access to the rule of 55. With a 401, you might be able to begin taking withdrawals from your account penalty-free before age 59 ½ if you leave your employer after age 55. While IRAs donât have this feature, you may be able to emulate it by taking subsequently equal periodic payments from your IRA.
Option : Cash Out Your 401
Lets get this out of the waythis is the worst thing you can do with your old 401.
If you withdraw the money from your 401 plan and take a direct cash distribution, youll have to pay any state and federal income taxes you owe on every last penny. And if youre under 59 1/2 years old, you can go ahead and add another 10% early withdrawal penalty to your tab.
But the worst part is youre robbing yourself of the chance to continue earning tax-free or tax-deferred growth on your investments for years, maybe decades. Its just a bad idea all around, folks.
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The Option To Convert To A Roth
An IRA rollover opens up the possibility of switching to a Roth account. s, a Roth IRA is the preferred rollover option.) With Roth IRAs, you pay taxes on the money you contribute when you contribute it, but there is no tax due when you withdraw money, which is the opposite of a traditional IRA. Nor do you have to take required minimum distributions at age 72 or ever from a Roth IRA.
If you believe that you will be in a higher tax bracket or that tax rates will be generally higher when you start needing your IRA money, switching to a Rothand taking the tax hit nowmight be in your best interest.
If you’re under the age of 59½, it’s also a lot easier to withdraw funds from a Roth IRA than from a traditional one. In most cases, there are no early withdrawal penalties for your contributions, but there are penalties if you take out any investment earnings.
Your 401 plan rules may only permit rollovers to a traditional IRA. If so, you’ll have to do that first and then convert the traditional IRA into a Roth. There are a number of strategies for when and how to convert your traditional IRA to a Roth that can minimize your tax burden. Should the market experience a significant downturn, converting a traditional IRA that is down, say 20% or more, to a Roth will result in less tax due at the time of the conversion. If you plan to hold the investments until they recover, that could be an attractive strategy.
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. It’s important to note that if you have the check made out directly to you, taxes will be withheld, and you’ll need to come up with other funds to roll over the full amount of your distribution within 60 days.
To learn more about the safest ways to do IRA rollovers and transfers, download IRS publications 575 and 590-A and 590-B.
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Balance Less Than $1000
If you have less than $1,000 in your 401, your employer could give you a lump-sum check for the amount.
If you didnât intend to receive your funds in this manner, youâll have 60 days from the date you terminated your 401 to roll the funds over to your current 401 or an IRA. Otherwise, the IRS will hit you with a 10% early withdrawal penalty tax for the amount.
