Millions of Americans have changed jobs over the past year. And while career change can be exciting, it can also raise many questions, including: Should I roll over my 401(k) plan into an IRA?
Retirement plans like 401(k)s, 403(b)s and IRAs qualify for tax benefits. That makes them an appealing way to save for retirement. But it also means there are rules about how you can use them. When you leave a job, many times you can leave retirement funds in your former employer’s plan. But you could also opt for a rollover, which allows you to move the funds while retaining their tax benefits.
Sometimes a rollover is beneficial because it allows you to consolidate retirement accounts, keeping everything in one place. But there are a number of other pros and cons you may want to consider before rolling 401(k) funds into an IRA.
These tips can offer some guidelines to help you determine if rolling over your 401(k) to an IRA makes sense for you.
IRA vs. qualified plans
It’s true that traditional qualified plans and IRA accounts share many similarities. Both IRAs and qualified plans typically come in two varieties:
- Traditional: These accounts allow you to grow your money tax-deferred until it is withdrawn, at which time it is generally considered taxable income.
- Roth: These accounts are funded with after-tax money. This means that when you withdraw your money in retirement, you will not owe any tax on your withdrawals.
Additionally, both types of accounts also require you to reach 59 ½ before accessing all the funds; there is typically a 10 percent penalty for early distributions in addition to taxes that you may owe. With a Roth IRA, you can withdraw contributions prior to 59 ½, but not earnings.
There are also some other important differences. An IRA is owned by you as an individual, while an employer sponsored plan like a 401(k) is technically owned by the employer. Additionally, IRAs tend to offer more flexibility and investment options compared to 401(k) plans.
Benefits of a 401(k)
In some situations, you might have more options and access if you leave your funds in a 401(k) rather than rolling them over to an IRA. For example:
- If you need a loan
If you currently need a loan from your 401(k) or think you might need a loan in the future, some qualified plans will allow you to take out a loan against your retirement funds. Check your plan documents for details.
- If you might need protection from litigation or creditors
Money held in a qualified plan is generally protected from creditor claims, while protection for IRA assets varies according to state law.
- If you are dividing assets in divorce
Both types of retirement accounts can be divided during a divorce settlement, but if the spouse receiving the benefits needs the funds before age 59½, only qualified plan funds can be liquidated without penalty.
- If you leave your job after age 55
If you retire or leave your employer after age 55, your 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, however if you meet certain criteria, you may be able to make distributions from a 401(k) without owing a penalty. You may want to keep a portion of your funds in a qualified plan if you are working toward early retirement or believe you may not be able to work until you reach full retirement age.
Benefits 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 this case, a rollover from a qualified plan can be beneficial.
- Education expenses
A parent or grandparent may take an IRA withdrawal for qualifying educational expenses, such as for a child or grandchild’s college education.
- ‘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.
- Health insurance premiums during unemployment
If you are unemployed for at least 12 weeks, you may use IRA funds to pay for medical insurance. This can be an effective means of preserving your emergency fund while you seek new employment.
Should you pursue a Roth conversion?
When considering whether to rollover retirement funds, you may want to consider moving funds to a Roth IRA or Roth 401(k). You would owe tax on the funds you convert in the year that you convert them. But from that point forward, you will enjoy the benefits of a Roth account.
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.
What to do about the company stock in your qualified plan?
If your qualified plan includes company stock that has appreciated in value over time, your tax advisor can help you figure out 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.
Consult a tax expert for advice
Your decision regarding the potential of moving your retirement funds could impact your taxes and your overall financial plan. That’s why it’s a good idea to consult with a financial advisor and a tax advisor to ensure that your decision works for your situation and goals.
*No investment strategy can guarantee a profit or protect against a loss.
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