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Things to consider before you move your 401k into an
IRA
by Mike Rowan, eRollover.com
Typically when you leave a job, you should roll over your 401(k) to an IRA. Rollovers allow you to continue delaying taxes on your nest egg as it accumulates and avoid an early-withdrawal penalty. However, many people choose to leave their 401(k) with their old company, or roll it into their new company’s plan. There are several points to be aware of when making this choice with your 401k or 403b plan. Here’s how to decide if a 401(k) rollover to an IRA is right for you.
Think about fees and hidden charges
Americans transferred $195 billion from 401(k)-type plans to IRAs
in 2006. But rollovers are a wise move for retirement savers only
if the IRA charges lower fees than the 401(k) plan at the old or
new job. Sometimes the IRA is a better deal, especially if the
401(k) is through a small business. But large companies often
negotiate institutionally priced investments with lower costs than
individuals can get on their own from retail IRAs. Low expenses
make those 401(k)’s a much better place to keep your nest
egg.
Rolling over a 401(k) to a high-priced IRA can cost you dearly,
according to Hewitt Associates, a human resources consulting firm
that processed more than 150,000 rollovers in 2006. A 35-year-old
employee who changes jobs and leaves behind $33,000 in a 401(k)
with typical institutionally priced investments can expect to have
squirreled away $404,105 by age 70, according to Hewitt. If the
same employee rolled the balance into a typical retail IRA
(assuming in both cases an 8 percent annual return before fees are
subtracted), he would have only $366,424 at 70. That’s a
difference of $37,681.
Review the
investment
options in your 401k or retirement plan
IRAs almost always have more investment choices than
401(k)’s. The main reason for rolling it over into an IRA is
diversification and more control over your retirement money. In an
IRA, you can invest in individual stocks, bonds, and any mutual
fund you want to. Savvy investors who already know they prefer
low-cost
index
funds over exchange-traded funds, or vice versa, will
enjoy the freedom of an IRA.
But retirement savers who aren’t likely to peruse their mutual fund prospectus might enjoy a smaller array of options already vetted by their employer or plan sponsor. Someone has limited the choices to a reasonable number and done a screen for you. You can do an asset allocation analysis with the funds that are offered and typically set yourself up just fine. If you are satisfied with the investments that you have, then you might want to leave your money there.”
Watch out for penalties.
If you are going to move your 401(k) to an IRA or your new 401(k)
plan, you need to watch out for penalties. Job-hoppers can save
themselves a lot of trouble-and money-by having the
former employer send the cash directly to the new financial
institution. You can do unlimited direct rollovers on an annual
basis.
If you take the old 401(k) into your own hands, your employer will cut you a check for the balance, minus 20 percent withholding for income taxes in case you decide to keep the money. Then, you generally have 60 days to put the cash into a qualified tax-deferred account. If you don’t, Uncle Sam will keep the 20 percent (plus any additional amount you owe at tax time). This also means you have to come up with the absent 20 percent from another stash if you want to roll all of the distribution into an IRA. Only one rollover in this manner is allowed every 12 months.
Don’t Move Company Stock
Stock of the company you work for gets special tax treatment when
held in an employer-sponsored 401(k). If there’s employer
stock inside the 401(k), you may want to not roll that portion into
an IRA.
Here’s an example: An employee buys $100,000 worth of company stock in his 401(k) plan, and it grows to be worth $1 million. If that stock is rolled over to an IRA, when it’s withdrawn, it will be taxed as ordinary income at a rate of up to 35 percent. Instead, Burkemper recommends that workers consider withdrawing the stock from the retirement plan. The original $100,000 investment would be taxable as ordinary income in the year of the distribution. But there is no tax on the $900,000 stock appreciation until it is sold. And then it would be taxed at the long-term, capital-gains rate of 15 percent. That would save the hypothetical borrower in this example $180,000 in taxes, assuming that income and capital-gains tax rates stay the same. If you roll it over to the IRA, that tax benefit is gone.
Think about Loan options for 401k and IRA
Plans.
Loans on your 401k or your retirement stash to cover current
expenses is never a good idea. But if your back is up against the
wall financially, you can generally take loans only from a 401(k)
and not from an IRA. If you roll it over to an IRA, the only way
you can get access is to pay taxes and the penalty.
Estimate your retirement age.
With an IRA, there is a 10 percent penalty if you make a withdrawal
before age 59½. But retirees can begin taking penalty-free
401(k) withdrawals at age 55. If you’re 56 and think you
might need access to a 401(k), you may not want to move it. This
can be circumvented by utilizing the substantially equal
distribution provision, otherwise known as 72t, where you can
access your money, but have to take the same amount for 5 years or
age 59 1/2.
At age 70½, retirees must take required minimum
distributions from their
retirement
accounts . There’s one exception: If you’re
still working, you don’t have to take the distribution from a
401(k)-and pay the extra taxes that year-unless you own
more than 5 percent of the company.
Consider your heirs with regards to Estate
Planning
Most 401(k) plans will force your heirs to take the assets soon
after you die, which can be a big tax burden on your loved ones.
Some 401(k) plans allow only spouses to roll inherited 401(k)
dollars into an IRA. If you’re going to stay in the plan, you
better make sure it allows you to do a nonspousal rollover into an
IRA. IRAs typically give retirees more freedom to allow heirs to
take required minimum distributions instead of a lump sum and make
it easier to set up multiple beneficiaries. If your
employer’s 401(k) plan doesn’t make it easy for your
heirs to space out the tax payments, you might want to roll over
the money into an IRA.
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