IRA Rollover Rules and Key Considerations: 5 Must Knows
Thinking about a rollover from your old 401(k) or other employer sponsored retirement plan to an Individual Retirement Account (IRA)? It’s a pretty simple move that could open up more investing choices.
After many generations where a one-company career was the norm, job hopping is becoming more regular. Changing jobs can complicate keeping track of employer-sponsored qualified retirement plans (QRP), which are often 401(k)s. But what about when you retire and leave the workforce for good? What should you do with your 401(k) then?
This process involves IRS regulations, so it’s understandable if you have many questions. Typically, once your employment ends, you have four options for your company-sponsored retirement assets:
- Leave all or part of the assets in your former employer’s plan, if permitted.
- Roll the funds into a new employer’s plan (assuming you continue to work), if available and rollovers are permitted.
- Roll over the assets into an Individual Retirement Account (IRA).
- Cash out the balance and pay the applicable taxes and penalties (which depend on your age and circumstances).
There are many considerations to keep in mind with each, such as withdrawal options, investment choices, services, fees, tax implications and your unique financial needs and plans for retirement. Let’s tackle five of the biggest questions and concerns to help get you “rolling.”
1. Simplicity Can Make Life Easier.
A rollover to an IRA is simply another opportunity for potential tax-deferred investment growth, usually with more investment options and greater flexibility than workplace QRPs. It is important to consider and compare investment-related expenses for your employer plan, a new employer plan, as well as for a new IRA. This comparison could include plan administrative fees, service fees, sales loads and commissions on the underlying investments that the plan or the IRA may incur.
Additionally, rolling your 401(k) from previous employers has the potential to be more convenient. With your accounts in one place, you can get a better look at your overall financial picture and see if your assets are properly diversified or if they need to be reallocated. Plus, maintaining fewer accounts may help you reduce maintenance fees.
IRA rollovers are not all-or-nothing. You can use an IRA rollover to move just a portion of your funds from one IRA to another or to roll over part of a QRP to an IRA. Although you can opt for a rollover at any age, there are a couple of important ages to keep in mind.
You can begin taking IRA distributions after turning age 59½. That differs from 401(k)s, which you can tap beginning at 55 if you meet certain criteria. If you need more age flexibility, you could consider leaving some funds in a 401(k). Now, whether your funds are in a 401(k), a rollover IRA, or a traditional IRA, you have to start distributing and paying taxes on the overall total when you’re 70½. That’s what’s known as a required minimum distribution, or RMD, which we cover in greater detail below.
2. A Rollover Is Not A Taxable Event.
When rolling funds from an employer-sponsored plan to your IRA, you can avoid mandatory tax withholding by requesting a direct rollover. In this case, although the check may be mailed to you, it will be made payable directly to your new trustee or custodian. If, on the other hand, the assets are distributed in your name, you have 60 days to re-deposit them in a plan or face taxes and other penalties.
3. Still, Don’t Run Afoul of The IRS.
One benefit of an IRA is that you defer taxes over the life of the account. But at a certain point Uncle Sam wants his cut. Taxable IRAs are usually seen as one total dollar amount in the eyes of the IRS.
Required minimum distribution, or RMD, kicks in at age 70½. The amount you must withdraw is calculated annually (don’t forget to rework the numbers each year) based on a combination of life expectancy and account value as of December 31 the year before this age milestone. Don’t forget this rule—the penalty fee is a steep 50% of your RMD.
IRA RMDs can be taken in aggregate; so if you have multiple traditional IRAs, you can withdraw from one account to satisfy the RMDs for the multiple traditional IRAs. Another thing to keep in mind is if you have to take an RMD from a 401(k) it needs to be done separately from your IRAs and cannot be in aggregate. For example, if you have two previous 401(k)s, you must take a RMD from each plus any from your traditional IRAs. Since Roth IRA distributions are tax-free, they are not subject to RMDs.
An important item to note: RMDs are not eligible for rollovers. If you’re still working at 70½, you may not be required to take RMDs from your current employer’s plan, such as a 401(k). This may be advantageous for those who plan to work into their 70s.
It’s important to the IRS (and to you) to separate your before-tax and after-tax withholding 401(k) contributions. If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.
You might opt to convert after-tax contributions directly over to a Roth IRA to separate them from before-tax contributions–in most cases with no tax consequences. If you have a 401(k), it can only be rolled over to a traditional IRA. After that, you can then convert from a traditional IRA to a Roth IRA. Commingled IRA assets might require you to file an IRS form 8606 with your annual tax return to protect what should be tax-free withdrawals of those contributions.
4. Move Assets In-Kind, Or Liquidate?
When you left a job for whatever reason, “liquidating” (selling) your 401(k) investments used to be the common route—say goodbye to your soon-to-be-former coworkers, then wait for a check to arrive in your mailbox. You’d then reinvest that money in your new company’s retirement plan.
But so-called in-kind, or trustee-to-trustee, transfers are becoming more common. In many cases, you can shift assets from one custodian to another, without selling anything, in what’s known as a “transfer-in-kind.” Your existing stocks, mutual funds, and even exchange-traded funds (ETFs) may be able to be moved to your new account.
If your old 401(k) includes company stock, you might explore the advantages of net unrealized appreciation (NUA). This allows a participant to withdraw the company stock “in-kind.” The cost basis of the stock will be recognized as income in the year of the withdrawal, but NUA can substantially reduce future taxation (when required distributions force their liquidation) and ensure the most optimal taxation of these assets.
More and more 401(k) providers are allowing in-kind transfers. But ask the appropriate expert first to make sure you understand how it works.
5. How Do I Begin?
If you plan to roll over, transfer, or cash out, call your 401(k) plan administrator to request the distribution. Sometimes you have to fill out a distribution form, but increasingly, 401(k) providers are accepting verbal instruction for rollovers.
Remember, using the IRS website, or better yet, contacting your tax professional, is always advised. Research is empowering in investing decisions, and rollovers are certainly no exception.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.