Decisions surrounding whether or not to convert an existing retirement plan to an IRA can be difficult for many. An IRA typically offers greater investment options, lower fees and increased flexibility.
Understanding the regulations surrounding retirement plans can be daunting, as financial institutions vie for your custom and compete for your business. Therefore, knowing and understanding these varying rules is vitally important.
Taxes
Your workplace retirement plan administrator can arrange for direct rollover, meaning they send the distribution directly to your new IRA provider and thus avoid mandatory federal income tax withholding. However, cashing out means making up for it within 60 days or face a 10% penalty (with some limited exceptions).
Moving your old 401(k) funds can provide better investment options than what are offered through workplace plans, which often charge higher management and administration fees that eat into returns over time.
Your options include rolling your 401(k) funds into an Simplified Employee Pension (SEP) or SIMPLE IRA – qualified workplace retirement accounts designed to cater specifically to small businesses that typically feature lower fees than a traditional IRA. You could also opt to leave them invested with your former employer’s 401(k), however income taxes and possibly an early withdrawal penalty of 10% apply unless you reach age 59 1/2.
Fees
By switching your 401(k) funds to an IRA, you can lower the fees charged by financial institutions – an essential step when considering long-term returns of investments. Furthermore, an IRA offers greater investment choices while most 401(k) plans limit you to just a set of funds from which your employer might provide limited choices.
Once again, to avoid potential tax penalties and ensure tax-free transfer of funds between accounts. To do this directly is known as direct rollover; otherwise be sure to transfer them within 60 days in order to remain tax-free. Some 401(k) plans allow borrowing against their funds or offer different creditor protection than IRAs which could also influence your decision on whether or not to roll them over.
Withdrawals
If you have multiple 401(k) accounts from previous jobs, consolidating them into an IRA will simplify record keeping. But you must transfer them within 60 days or face tax penalties.
Some individuals prefer leaving their 401(k) savings where it is, particularly if the plan offers suitable investment options and has reasonable fees. Unfortunately, doing this may limit investment choices and make communicating about it harder.
Financial institutions vie for your IRA business, offering one-time incentives such as free stock trades on initial deposits in order to tempt you. But before selecting an IRA provider, make sure you do your research first – the IRS sets consistent rules across providers, so any will adhere to them all.
Rollovers
Typically, funds distributed from an employer retirement plan can be directly transferred into an IRA. However, if you receive your distribution as a check made payable directly to you from your former employer, they must withhold 20% for taxes before sending it on its way. Additionally, any amount not deposited into an IRA within 60 days could be considered an early-withdrawal penalty of 10% of its value.
An indirect rollover is usually the best solution; this involves having your old retirement account’s administrator send its funds directly to your new provider for deposit into an IRA account with them, usually through electronic fund transfer or wire. That way, no money ever touches you! In other cases, plans may mail a check payable directly to them with instructions on how and when to forward it on. Just ensure your new provider knows which IRA number has been filed away!
