If, like many Americans, you are nearing retirement or starting a new job, part of the transition planning is to deal with your 401(k), 403(b) or 457 plan. For most, no solution is more sensible than establishing an IRA rollover account. There are several advantages to the move, including tax-free consolidation of retirement fund balances and much greater control over investment decisions while preserving all the tax-deferred benefits of any 400-type plan.
Setting up a rollover account is simplicity itself. There are two methods to accomplish the IRA rollover; direct and indirect transfer. Either involves no more than a couple of pages of paperwork and a phone call or two.
In a direct rollover, also known as a “trustee-to-trustee” transfer, the funds are moved directly from the employer plan to your newly designated IRA custodian.
In an indirect (or “rollover”) transfer, your former employer sends you a check for the amount in your retirement account, minus 20 percent (as required by law) to cover any possible income tax on the rollover. You then have 60 days to complete the rollover into an IRA, including the withheld 20 percent — which comes out of your pocket but is later reimbursed by the IRS. If you don’t make good on the missing 20 percent, the IRS will treat it as a taxable distribution (even though you actually never got the money!) and you’ll be subject to a 10 percent early withdrawal penalty on the amount if you are younger than 59.
As you may well guess, indirect transfers can easily open the door to complications and financial heartburn. For that reason, the financial planning community largely favors the direct rollover.
A few caveats to bear in mind:
- Fees and service levels vary among IRA custodians, so do your homework.
- Rollover contributions don’t count towards your annual IRA contribution limit, so be sure to make your regular contribution. And continue to contribute to your new employer’s 400-type plan to take advantage of the match (whatever it is). It’s free money you don’t want to forego.
- If you want to roll over your old plan proceeds into your new employer’s 400 plan, you will have to set up a dedicated IRA and keep the funds separate from existing IRA assets. If the funds get mingled, you’ll lose your eligibility to move the funds into your new employer’s 401(k), 403(b) or 457.
- If you hold company stock in your old employer’s plan, moving it could present some tax-related problems regarding net unrealized appreciation. Consult your financial advisor.
There are many benefits to rolling your plan funds into an IRA. For instance, you are free to name any beneficiary you want to receive the proceeds upon your demise (if you leave the plan assets with your former employer and they have not amended their plan, it may be difficult to leave benefits to a domestic partner or family members). An IRA also permits much broader investment flexibility than a typical 400-style plan, giving you the leeway to manage your retirement portfolio in a more cohesive and nuanced way that more accurately reflects your tolerance for risk.
If you have any questions on this topic, please feel free to call us. We’ll be happy to help.