IRA and 401(k) Rollovers

When you retire from a job, you need to decide what to do with your employee-contributed 401(k). One option is to transfer your account to an IRA. Transferring retirement accounts actually has some benefits, like potentially lower fees and a larger selection of investment options. That said, some tax implications can occur when you transfer accounts. Before you get going, it’s important to be informed of your options and know what to expect to secure your retirement funds or avoid a financial hit.

BENEFITS OF IRAS

IRAs provide more information and options about where to put your money, whereas 401(k)s may have limited investment options. This is beneficial because, with the assistance of an IRA, you can avoid high investment fees while still investing in a variety of places. IRAs also let you withdraw early from a retirement account. Typically, you shouldn’t do this, but if the need arises, IRAs provide more flexibility.

INDIRECT VS. DIRECT 401(K) ROLLOVERS

Direct Rollover

With a direct rollover, your former retirement plan assets are directly transferred from your 401(k) plan to a traditional IRA. The electronic transfer is typically easy and seamless, and there are no tax requirements during this part of the process.

On the other hand, transferring retirement assets from a 401(k) to a Roth IRA is a bit more complicated because there are taxes involved. Roth IRAs are funded with after-tax dollars, while 401(k)s and traditional IRAs are funded with pre-tax dollars.

With traditional IRAs, your retirement withdrawals are taxed like ordinary income. Roth IRAs offer the benefit of tax-free withdrawals during retirement, so if you decide to transfer your assets from a 401(k) into a Roth IRA, you’ll have to pay taxes on that amount.

Indirect Rollover

With direct rollovers, your money gets transferred from one account to another. With an indirect rollover, you receive a check from your 401(k) with 20% of it withheld for tax purposes. You have 60 days to deposit money into another retirement account. While direct rollovers are easy and simple, indirect rollovers can serve as a short-term loan, if and when you need it.

If you have just ended your job and are looking for another one, you can use the money from the indirect rollover to hold you over until you find employment. As long as you redeposit it into another retirement account within 60 days, you won’t get penalized. After those 60 days are up, and if you haven’t deposited it, you will have to pay a 10% penalty and have to report the amount withheld on your tax form as both income and taxes paid.

Then, it is up to you whether to deposit the money into another retirement account or make up for that money from other funds. It is not in your best interest to hold the money in the account for more than 60 days because you’ll have then depleted your 401(k). You worked hard to contribute to that account, and your retirement funds should be a priority.