IRA Rollovers: When to Hold 'Em and When to Fold 'Em
March 9, 2015 | Your Finances
Though both are designed for retirement savings, IRA accounts and employer-sponsored qualified retirement plans—such as 401(k) or 403(b) accounts—are different financial vehicles governed by different rules. Before you roll funds from a qualified plan into an IRA, it’s important to consider your specific circumstances and which vehicle would be best for you.
Traditional qualified plans and IRA accounts are similar in two ways. First, both vehicles allow your money to grow tax-deferred until it is withdrawn, at which time it is generally taxable income. Both types of accounts also require you to reach a certain age before accessing the funds; there is typically a 10 percent penalty for early distributions.
When to Take Advantage of Qualified Plans
In some situations, you might have more options and access if you leave your funds in a qualified plan rather than rolling them over to an IRA. For example:
1. If you need a loan. Some qualified plans allow you to take out a loan against your retirement funds, while IRAs do not. Check your plan documents for details.
2. If you might need protection from litigation or creditors. If you might be the target of litigation, or you have creditor claims in bankruptcy, your assets will have greater protection in a qualified plan. Qualified plan funds are generally protected from creditor claims, while protection for IRA assets varies according to state law.
3. If you are dividing retirement assets in divorce. Assets from a qualified plan provide the most flexibility for the receiving spouse in a divorce settlement. Both types of retirement accounts can be divided, but if the receiving spouse needs the funds before age 59½, only qualified plan funds can be liquidated without penalty.
4. If you leave your job and need assets after age 55. For individuals who retire or leave their employer after age 55, qualified plan assets can be taken at an earlier age than IRA assets. A distribution from an IRA between ages 55 and 59½ will incur a 10 percent penalty, while the same distribution from a qualified plan will not.
When You Benefit from an IRA Rollover
There are some situations where you are allowed to withdraw funds from an IRA before age 59½ without penalty (although you’ll still trigger normal income tax), in which case a rollover from a qualified plan can be beneficial:
1. Education expenses. You may take an IRA withdrawal for qualifying educational expenses, such as for children’s or grandchildren’s college education.
2. “First-time homebuyer” in the family. You may withdraw up to $10,000 from an IRA to supplement a home down payment for yourself—or a child, grandchild, or spouse—who wants to purchase a home and has not owned one for at least two years.
3. Health insurance premiums during unemployment. If you are unemployed for at least 12 weeks, you may use IRA funds to pay for medical insurance.
The Time to Consult a Tax Expert for Advice
Your financial professional can help you identify your options for IRA rollovers and explain how to invest your retirement assets to your best advantage. When your decisions have tax implications, it is best to consult your tax advisor. Here are some rollover questions you may want to discuss:
1. Roth conversion. Consider investing in Roth IRA or 401(k) accounts, retirement vehicles that invest after-tax dollars and potentially distribute assets tax-free. You can generally convert traditional retirement accounts to Roth accounts if you pay taxes on the funds. If you also want your heirs to be able to convert the retirement assets they inherit from you into Roth accounts, talk to your tax advisor about how best to accomplish your goals with qualified plan dollars.
2. Taxing securities in retirement funds. If your qualified plan includes company stock that has appreciated in value over time, you need to understand the tax implications before making a rollover. Check with your tax advisor on the best way to take these securities out of the qualified plan. There are potential tax advantages to taking the securities in a lump sum rather than rolling them over to an IRA.
As you look at the options for managing your assets, understand the differences between retirement savings vehicles—and be sure to consider your needs before rolling over funds from a qualified plan to an IRA. Contact your financial Professional and tax advisor to help you determine the direction that is best for you.