When it comes to ensuring a comfortable retirement, your 401(k) is one of the best weapons in your arsenal. Year after year, you’ve been diligently socking away your hard-earned dollars into this savings vehicle…but what happens to this money if you switch to a new job? The average working adult changes jobs 12 times during their career. (1) This means the days of sticking with one company for an entire career are long gone, so the odds are pretty good you’ll need to make a decision when your current employer becomes your former employer.
Enter the 401(k) rollover. Everyone wants to streamline their financial portfolio as much as possible (and pay less in fees and have more investment options) while also still tailoring it to their specific situation. So it’s crucial to learn about what a 401(k) rollover is, and how to do one with your investment accounts. Let’s discuss the basics.
What Is a 401(k) Rollover?
A 401(k) rollover is an option you have when you leave a company and want to transfer your investments into an individual retirement account (IRA). Normally people do this if they are leaving a company, switching to a new company, or retiring, but you can also do a 401(k) rollover into another 401(k) with a new employer. (2)
Pros and Cons of a Rollover
The main benefits of a rollover from a 401(k) to an IRA are the following:
- More options. Most 401(k) plans have a limited selection of mutual funds and bonds to invest in. IRAs offer those plus other options, such as stocks, exchange-traded funds, and income-producing real estate. (3)
- Lower expenses and management fees. This will vary depending on your 401(k), but usually having an IRA decreases management fees, administrative fees, and expenses related to each fund you have.
- Convert from a tax-deferred account to a Roth account. Contributions to a 401(k) plan or traditional IRA are made using pre-tax dollars, which means distributions are taxed at the time of withdrawal. Rolling money from a traditional 401(k) into a Roth IRA gives you the option of paying taxes now so that you will not have any taxes due at the time of withdrawal in the future. If this is an option you are considering, you should discuss with your advisor and your tax professional to consider current and future forecasted tax rates to see which pathway makes the most sense.
Required Minimum Distributions (RMDs)
Tax-deferred retirement plans are subject to required minimum distributions (RMDs). Taxes are due at the time of withdrawal. The SECURE Act changed the timeline for taking RMDs for both IRAs and 401(k) plans. For IRAs, anyone who reached age 70½ on or after January 1, 2020, will not be required to begin taking RMDs until April 1st of the year after they reach age 72. (4) Failure to take RMDs at the appropriate time will result in a hefty 50% penalty on any distributions you fail to take on time. (5)
Some 401(k) plans (but not all) allow you to leave money in the plan until you retire, effectively delaying RMDs, as long as you are still working for the employer who sponsored your 401(k) plan. If you leave any 401(k) funds in your prior employer’s account, the exception will not apply to those funds. (6) The exception also does not apply to IRAs; if you have funds in an IRA, you must start taking RMDs when you reach the age limits regardless of when you retire.
Both IRAs and 401(k)s include a 10% penalty if you withdraw money before the age of 59½. The 10% penalty is in addition to taxes that you will owe on the money no matter what. There is one exception for 401(k) plans, known as the Rule of 55; if you retire at 55 or later, you can take penalty-free withdrawals from your current 401(k) sponsored retirement plan. The Rule of 55 does not apply to IRAs, nor does it apply to 401(k) plans still housed in a prior employer’s account.
How to Execute a Rollover
Thankfully, rollovers are pretty simple. Once you have chosen a bank, financial institution, or online investing platform, you contact your 401(k) plan administrator to let them know where you want your funds transferred. You can choose to do either a direct or indirect rollover. (7) A direct transfer is generally recommended because it is the simplest form of getting money from one point to the next, and you do not have to worry about how or when to deposit funds.
You also have the option of doing an “indirect rollover,” where your employer cuts you a check and you are responsible for depositing the funds into a new tax-deferred investment account within 60 days. Your employer will be required to withhold 20% of the funds to pay taxes due (this 20% comes back to you in the form of a tax credit when you file your return). That means you will only receive a check for 80% of the value of your 401(k), and you will need to replace the 20% withheld amount from your personal funds or another source. (8) If you fail to deposit the funds to a tax-deferred account within 60 days, the transfer will be treated as an early withdrawal and the entire amount will be subject to an additional 10% penalty.
Is a Rollover a Good Option for You?
You want all your hard work to pay off in retirement, so it’s vital to make the most of your 401(k)—no matter what twists and turns your career takes. Although the 401(k) rollover options are flexible, it can be confusing to know which path to take. Your situation is unique, so one-size-fits-all advice just won’t do. As with most financial decisions, it’s best to discuss your options with a financial professional before pulling the trigger.
We at Wurz Financial Services are here to answer your questions and help you evaluate your options. First we’ll take a deep dive to get to know you, discuss where you are now, and where you want to be in 5 years, 10 years, and beyond. We’ll then create a retirement road map to simplify your finances and help you accomplish your future goals, big and small. We don’t just tell you what to do—we work with you to come up with a plan that feels good to you.
Schedule a no-obligation consultation, and together let’s find out if we’re the right people for you to depend upon during your journey to a comfortable retirement. Contact us at 859-291-9879 or firstname.lastname@example.org today!
Darren Wurz is a co-owner and financial planner at Wurz Financial Services, an independent, family-owned and operated financial services firm dedicated to helping its clients transition from their working life to a comfortable retirement with confidence. Darren received his Master of Science in financial planning from Golden Gate University and also holds the CERTIFIED FINANCIAL PLANNER™ (CFP®) designation. He operates the Northern Kentucky/Cincinnati office of Wurz Financial Services and is an active member of the Northern Kentucky Bar Association, the Northern Kentucky Chamber of Commerce, and the Covington Business Council. To learn more about Darren, connect with him on LinkedIn.