When you leave a job or retire, you must decide what to do with the money you have in your employer-sponsored 401(k) or other retirement plan.
Depending on your specific circumstances, you may have four different options to consider:
(1) In most cases if you are younger than 55, the option to cash out your 401(k) plan is probably not your best choice as your distribution would be treated as taxable income and be subject to an early withdrawal penalty.
(2) When some people leave their job or retire, they choose to leave their money behind in their old 401(k) plan.
(3) If you are moving to a new job, you may decide to transfer your savings from your old 401(k) into the 401(k) of your new employer.
(4) A fourth option is a rollover of your savings from your 401(k) into an individual retirement account or IRA. A rollover preserves the tax-deferred status of your retirement assets, allowing you to avoid current taxes and early withdrawal penalties on the rollover distribution.
Do I have to wait until I leave a job or retire to roll over a retirement account? No. An in-service withdrawal, which is allowed in most qualified retirement plans, is when an employee withdraws their plan assets and rolls them over into an IRA while continuing to work for their current employer. Some plans require that in the case of an in-service withdrawal there must have been a triggering event, such as reaching normal retirement age, disability, plan termination or reaching age 59 ½.
A direct rollover is when you instruct your plan administrator to make a payment of the money in your 401(k) plan directly to your IRA account. In a direct rollover, the distribution is transferred directly by the employer-sponsored plan to the employee’s IRA and is never actually transferred to the employee individually.
In contrast, an indirect rollover is when the employer-sponsored plan makes a distribution (or payment) directly to the employee, the size of which distribution is decreased by the mandatory 20% withholding tax. In the case of an indirect rollover, you then have 60 days to deposit all or a portion of the distribution in an IRA or other qualified retirement plan.
When you weigh these advantages of a rollover, you may consider that it is a viable option for you:
1. Freedom – With an IRA, you will have a wider range of investment options available to you. Many 401(k) plans limit employees to a list of average performing mutual funds with high fees and expense ratios and prohibit the purchase of individual stocks or low-cost exchange traded funds (ETFs). With your IRA you can build a portfolio that better matches your vision and market expectations.
2. Control – Many 401(k) plans have restrictions, such as limitations on how the employer contribution portion of the account can be invested. From your perspective, once you leave a job or retire, the origin (you or employer) of your retirement assets is not important, your top concern is selecting the best performing assets that strategically align with you and your investment goals.
3. Simplify – Many of us will work for several employers in the years leading up to our retirement. Consolidating old employer-sponsored plans and IRAs into one IRA will lower management fees along the way and allow all retirement assets to be managed under one asset allocation plan. Once you reach age 73, you must consider how required minimum distributions (RMDs) fit into your retirement withdrawal strategy. Having consolidated your old plans and IRAs will make this task a far easier one to manage.
Rick Welch is a Registered Investment Advisor (RIA) and chief investment officer of Academy Wealth Advisers. He can be reached at 215-603-2976 or rickwelch@academywealthadvisers.com.
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