If you are transitioning out of a workplace retirement account, be sure to follow all necessary steps for tax penalties to avoid them. Consult a financial advisor.
IRAs offer investors thousands of investment options, such as no-load mutual funds and ETFs, all under one umbrella account. You can then select your investment strategy before beginning to invest.
1. Direct rollovers
Direct rollovers are the preferred method for moving retirement savings between employers. This involves an electronic transfer or check being sent directly from the plan administrator of your former employer to your IRA provider in which funds will be moved – this does not trigger income taxes or early withdrawal penalties and should take no more than 60 days to take place.
Indirect rollovers can be more complex, as they typically take the form of a distribution check made out directly to you with a mandatory 20% tax withholding amount deducted by law. You are then responsible for depositing this money into an IRA within 60 days or risk having it considered a taxable distribution and incurring income taxes and a 10% penalty tax penalty tax penalty tax liability.
Indirect rollovers can only take place between similar plans, such as Traditional IRA and Roth IRA accounts. According to IRS regulations, moving from a 401k account into an account such as personal bank or brokerage may constitute a transfer and not direct rollover.
2. Indirect rollovers
Moving retirement assets between accounts requires two approaches: Direct and Indirect Rollover. Under a Direct Rollover, your plan sends a check directly to the new firm who handles everything else for you; alternatively an indirect rollover requires that assets are distributed directly to you with 60 days for redepositing into an IRA – failing which the distribution could be treated as a taxable withdrawal and may incur early withdrawal penalties.
Employers must withhold 20% of your pretax pay as taxes; if you can collect all $50k within 60 days and deposit it into an IRA within that time, then the IRS will refund their initial withholding. Otherwise, it will be treated as having been received as an early withdrawal distribution and subject to tax and an early withdrawal penalty of 10% if you’re younger than 59 1/2. A direct rollover would help avoid this.
3. Consolidation
Consolidating retirement savings may be beneficial in certain instances, particularly if multiple 401(k) accounts from different employers exist or charge high fees.
Keep in mind that you only have 60 days from when you receive a retirement plan distribution to roll it over into another qualified plan or IRA – that doesn’t include time passed since leaving your previous employer.
If you plan to cash out your 401(k) before turning 5912, be aware that any distribution will be taxed at ordinary income rates with possible 10% penalties applied. To avoid penalties altogether and roll over funds into an IRA instead of taking out a 72(t) distribution.
As you consider options for rolling over your IRA, look for an investment custodian with low or no fees (either through a brokerage with $0 trading commissions or through a robo-advisor) and low expense ratios; doing so could save thousands over time.
4. Fees
Transfer fees should not apply when making the switch from 401(k)s to IRAs. But you should consider any associated fees with your new account carefully – some financial institutions have higher IRA fees than 401(k) accounts and may charge hidden ongoing charges that you might not even know about.
One study by Pew found that retirees lose approximately $980 million each year due to higher IRA fund fees – an enormous sum when considered against people on fixed incomes who need every dollar possible to make ends meet.
Direct rollovers offer an effective solution by having your 401(k) check made out directly to the IRA custodian instead of you; this allows the account to avoid withholding 20% for taxes, and avoids the 10% penalty if you’re under age 59 1/2. Indirect rollovers may also be tax-free provided all funds are deposited within 60 days, though you must report it as part of Form 1040X: Amended Return – see our blog post for more information on that form.
