Retirement Plan Options: What You Need to Know
Most of us will work for several different employers throughout our careers, which means we may have multiple 401(k)s floating around. We have several options for what to do with those accounts, including leaving them where they are and cashing them out, rolling to new company plan (if allowed) and moving into an IRA.
Let’s take a look at 401(k) rollover options.
What is a 401(k) Rollover?
A 401(k) rollover transfers money from an old 401(k) to an IRA or a new 401(k). Typically, you have 60 days to complete the rollover. If you miss the window, you’ll have to pay income tax on the entire amount.
Taking it With You
If your new employer offers a 401(k), you can roll your old 401(k) into the new one. Be sure to ask how long you need to be employed to participate. Some employers require new hires to be at a job for a certain number of days before they’re allowed to participate in the 401(k).
Once you’re able to enroll in the new plan, the rollover is simple. You can have the previous plan’s administrator deposit the balance directly into the new 401(k) by filling out a few forms. This is a direct transfer, made from one custodian to the next, and will ensure that you don’t have to pay any taxes or penalties.
Your other choice is to have the old 40(k) balance distributed to you via check. At this point, the 60-day clock is ticking. Be sure the new 401(k) is ready to receive the distribution before liquidating the old one.
Is transferring your old 401(k) to your new one a good option? It may be. Does the new employer offer options that align with your investment strategy? How are the fees?
Another reason for rolling over into a new 401(k) that most people don’t consider is the protections a 401(k) offers legally. The money in a 401(k) is often better protected from creditors than the money in an IRA, and 401(k)s are also protected from a company’s creditors should the company go bankrupt. Consider those things before opting for a rollover to the new 401(k).
Leave it in the existing plan
When you change jobs, some employer plans will allow you to leave your retirement assets in the plan. You will need to check with the plan to make sure that you are aware of any fees or costs associated with that.
Cash it out
You will have the option to cash out your plan and take the lump sum as a distribution.
Rolling Over to an IRA
How is rolling your employer sponsored plan into an IRA treated?
- A direct rollover from a 401(k) to an IRA is penalty and tax-free.
- The IRA lets you maintain the tax advantages your 401(k) provided.
- You could have more investment options. A typical 401(k) plan might have a few funds to choose from, but an IRA could give you hundreds of choices, including individual securities, ETFs, mutual funds, real estate, and bonds.
Traditional or Roth?
The main difference when deciding between a Traditional or Roth IRA for a rollover or anything else is when you will pay taxes, now or later?
In a Traditional IRA, your investment up to a limit is tax-deductible at the time of contribution. The money goes in pre-tax, and that amount is deducted from your taxable income. You’ll pay taxes on the contributions and their earnings when you withdraw the funds.
Traditional IRAs are subject to required minimum distributions (RMDs) at age 72, even if you’re still working. If you had a traditional 401(k), the rollover is easy since the 401(k) contributions were also pre-tax.
When you choose to roll over to a Roth IRA, the whole account is considered taxable income immediately. You have to pay both federal and state (if applicable) income tax on the amount you roll over. So long as you hold the Roth for at least five years and meet the withdrawal age requirement, your after-tax contributions and their earnings are tax-free.
Roth IRAs have no RMDs, so the money can remain invested and continue to potentially grow tax-free. If your previous 401(k) was a Roth account, you can only roll it over to a Roth IRA.
Traditional or Roth?
If you think you’ll be in a lower tax bracket during retirement than during your working years, a Traditional IRA may be the best option. And for those who expect to be in a higher tax bracket during retirement, a Roth IRA may be better for you.
If you want to hedge your bets, you may have the option to choose both! If the 401(k) administrator allows it, you can divide the distribution between a Traditional and a Roth IRA in any split you select.
Consider Your Retirement Strategy
The best 401(k) strategy is the one that fits best with your overall retirement strategy. Choosing the wrong option can throw your carefully created plan out of balance. If you have questions, we are here to help.