521 Capitola Avenue
March 22, 2021
So you’ve left your job, either for a new one, or for retirement. What do you do with your previous employer’s 401(k) plan? Cashing it out is a costly option, as it will result in taxes and penalties for early withdrawal. While you may be able to leave the account as it is, you will not be able to make further contributions or take a loan from the plan. Also, there may be further restrictions and fees if you are no longer an active employee.
Luckily, one of the benefits of a 401(k) is its portability. If you have found a new job, you can decide to rollover your former plan directly into your new company’s plan. However, if your new job does not offer a plan, or has too many rules, a rollover into an individual retirement account (IRA) may be the answer.
A 401(k) rollover that transfers the holdings of the account into an IRA can provide greater benefits after you have left the company:
Old 401(k) Account
Individual Retirement Account
Limited options which usually means a few mutual funds.
Most types of investments: mutual funds, individual stocks, bonds, ETFs, REITs, etc.
Fees & Costs
Plan administrator charges an annual fee. This is on top of the fees charged by the funds offered in the plan.
More investment choices gives the investor more control over expense ratios and fees.
Roth IRA Rollover
May or may not allow for direct Roth rollovers.
Usually, the 401(k) balance is paid out in a lump sum which could have major estate taxes imposed on the beneficiary.
Inherited IRAs have more payout options, and will have to be paid out over a longer period of time (10 years).
Former employees may find it difficult to be updated with plan details, changes, or get in touch with the provider.
Required to contact account holders in a timely manner with material information regarding the investments or account.
Similarly, if you are invested in the increasingly popular Roth 401(k), you can roll it over to a Roth IRA. You will find similar benefits to the traditional rollover method, with the continued advantage of tax-free withdrawals in retirement. A traditional 401(k) may also be rolled over to a Roth IRA. Remember, a 401(k) is pre-tax dollars so the amount you convert will be taxable. Though if you expect to be in a lower tax bracket for a particular year, or a higher tax bracket when you retire, you may want to take advantage of this. Check if your plan administrator permits rollovers to a Roth IRA.
Another convenience of a Roth IRA is that required minimum distributions (RMDs) are not applicable. For both traditional IRAs and 401(k)s, RMDs must begin at age 72. This does not apply to a Roth IRA.
A direct rollover is the preferred method to transfer your 401(k) account. To initiate the rollover, complete the required forms by both your plan administrator, and the provider of the IRA. The funds will be moved electronically, or by check to the new account. No taxes will have to be paid on the amount rolled over or its earnings.
An indirect rollover puts you in charge of depositing the money into the new account. There is a 60 day time limit on when the rollover must be completed, and 20% is required to be withheld for taxes. This is for taxes you will owe on the early distribution should you decide to keep the rollover check. Despite this withholding, you must make up the full amount in your deposit to the IRA if you want it to remain tax-deferred. Your withholding will be returned when you file your tax return for the year the rollover took place. These rules make this option a last resort.