By Brian Bloxom, ChFEBCSM
Your dream of a fulfilling retirement won’t become a reality without years of diligent planning and saving. And I’m sure you’ve been socking away your hard-earned dollars year after year into your trusty 401(k), right? But what happens to this money if you switch to a new job? It used to be that people would stick with one company for an entire career, but those days are long gone. In fact, the average working adult changes jobs 12 times during their career, (1) so chances are you’ll need to make a decision when your current employer becomes your former employer.
If you don’t understand what a 401(k) rollover is, now’s the time to learn—and how to do one with your investment accounts. After all, 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. Let’s discuss the basics of a 401(k) rollover.
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 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.
Cons of a Rollover
Some potential cons of a 401(k) rollover include:
- Creditor protection risks. Leaving your funds in a 401(k) might provide creditor and bankruptcy protections, which might not be the case with an IRA, depending on your state’s IRA rules.
- Less accessibility. Although it might be possible to get a loan from an employer-sponsored 401(k) account, you cannot from an IRA, which means the funds may be less accessible.
- Account fees. You may be hit with higher account fees compared to a 401(k), which has access to lower-cost institutional investment funds due to group buying power. (4)
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. (5) Failure to take RMDs at the appropriate time will result in a hefty 50% penalty on any distributions you fail to take on time. (6)
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. (7) 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. (8) You can choose to do either a direct or indirect rollover. 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. (9) 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 Right for You?
You want to make the most of your 401(k), your most reliable retirement savings vehicle. There’s a lot of flexibility with rollover options, but like many financial decisions, it can be confusing to know which path to choose; and when it comes to your retirement, cookie-cutter advice won’t do. Your situation is unique, so it’s wise to discuss your options with a financial professional before pulling the trigger.
We at Sentinel Wealth Partners would love to answer your questions and help you evaluate your options. After getting to know you and your unique situation, we will create a retirement road map to help you reach your financial goals. Reach out to us today by calling our office at 703-832-0164, sending an email to email@example.com, or using our online calendar.
Brian Bloxom is an Independent Financial Advisor, Chartered Federal Employee Benefits Consultant (ChFEBCSM), and Chartered Retirement Planning Counselor (CRPC) with 25 years of experience in financial advising. He founded Sentinel Wealth Partners to serve retirees, individuals approaching retirement, and individuals managing complex retirement plans such as company plans or federal benefits plans. His expertise and dedication to helping his clients achieve their goals make him a trusted resource that will help you feel confident in your customized retirement plan. Brian’s mission is to be available to his clients—all the time. He’s here to solve your problems, relieve your anxiety, and give you optimism for retirement. Because ultimately, your retirement should be about well-deserved enjoyment, and not about stress or anxiety. When he’s not working, you can find Brian spending time with his wife, Jessica, and their two sons, Spencer and Preston. He enjoys coaching soccer, serving in his community, golfing, and relaxing at his vacation home at Lake Anna, VA. To learn more about Brian, connect with him on LinkedIn.