401k And IRA Rollovers In A World Of Retirement And Job Transitions
With fewer companies offering pensions, more and more Americans rely on 401ks, IRAs, and similar retirement investment accounts to prepare for their retirement. Many of these qualified retirement accounts are offered and managed through employers.
Yet Americans are also changing employers at a historic pace. In 2021, 47.8 million Americans left their jobs — that's nearly 4 million job changes a month. Many of those career switchers held retirement accounts linked to their previous employer. What happens to those accounts when they leave?
If you have changed jobs, or you think you might, it's time to take a look at how your career choice could affect your retirement accounts.
Saving For Retirement
Retirement is a time of transition. It can give you a chance to simplify your life, or it can be a time to travel, explore new hobbies, or serve God in fresh ways.
Regardless of how you plan to spend your retirement, certain financial considerations need to stay top of mind to make your retirement dreams a reality. One decision you'll have to make is what to do with your 401k, or other employer retirement account when you change jobs.
What's an IRA?
An IRA is an individual retirement account that offers tax advantaged savings towards retirement. An IRA isn’t right for everyone, as contributions are often limited based on income. You can open an IRA at most financial institutions, and there are several types of IRAs to choose from, including traditional, Roth, SEP, and SIMPLE.
Most investors go with one of two main choices for an IRA: traditional or Roth. a traditional IRA can provide tax-deferred growth and, when done right, tax-deductible contributions. In other words, you don't pay taxes on the money when you contribute, but you will when you withdraw it in retirement.
Like a 401(k), One of the key benefits of an IRA is that it can allow you to save for retirement while deferring taxes on the money you contribute and the earnings you accrue. Which can be particularly beneficial if you will be in a lower tax bracket come retirement. Over 60 million American taxpayers — about 29% — hold an IRA with an average balance of $168,000. In general, the more money you earn and the older you are, the more likely you are to invest in an IRA (or a 401(k) for that matter).
What's a Roth?
A Roth (or Roth IRA) is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. That’s right, tax-free growth! Contributions to a Roth are made with after-tax dollars, which means you've already paid taxes on the money you're putting in. One word of caution, your Roth IRA must have been established for 5 years or more for the growth to be withdrawn tax free. After 5 years all withdrawals are 100% tax free.
This is different from a traditional 401(k) or IRA, where contributions are made with pre-tax dollars and taxes are deferred until withdrawals. About 10% of American taxpayers invest in a Roth, and these accounts hold an average balance of $41,000. In 2022, you cannot contribute to a Roth IRA if you’re married filing joint with a modified adjusted gross income of more than $214,000, or single with modified AGI over $144,000. This means many high-earner investors are not eligible, however, they may still be able to fund a Roth indirectly through a backdoor Roth IRA.
What's a 401(k)
The original 4019K0 is an employer-sponsored retirement plan, the 401(k) lets workers save and invest a portion of their paycheck before taxes are taken out. Similar to an IRA, it allows employees to make pre-tax contributions and provides tax-deferred growth. Taxes are not due on the money until it is withdrawn from the account. A special type of 401(k), called a Roth 401(k), gets funded with post-tax dollars and provides tax-free growth.
Many employers are now offering Roth 401(k) with like a Roth IRA is funded with after-tax dollars. Upon retirement these contributions plus all the growth can be withdrawn 100% tax free.
Although 68% of employees have access to this retirement vehicle, only about 41% of American workers actually contribute to a 401(k). With most employers offering a match on employee contributions, this is a sad reality.
If you are investing in a 401(k) and you change employers, or retire, you may want to consider a rollover.
What Are Rollovers?
A rollover is when you take money from one retirement account and move it into another. You can roll over your funds for a number of reasons, but usually, it’s because you’ve changed jobs and want to keep the money in a tax-deferred account.
Most often you have the ability to rollover an existing retirement account to an IRA, Roth IRA, or into a similar employer retirement plan, such as rolling over your 401k to your new employer’s 401k plan.
The IRS has established guidelines that govern rollovers. As of 2022, a rollover must be completed within 60 days of receiving an IRA or 401(k) distribution. Alternatively, you may also direct your plan administrator to roll over your accounts directly after you change jobs, thereby bypassing the possibility that you miss the 60-day deadline.
When Should You Rollover Your Investments?
Many people choose to roll over their 401(k) to an IRA when they retire or leave their job. This may provide them with greater control, more flexibility, and/or allow a trusted advisor to help manage these funds. In some cases, it can help simplify our already complicated financial lives and help ensure a more cohesive investment strategy.
Some people also choose to roll over their 401(k) to a Roth IRA. This can be a good move if you're expecting to have higher income (and therefore be in a higher tax bracket) in retirement and want to have more flexibility with your withdrawals.
However, you may want to consider some factors before making the switch to a Roth IRA. For example, if you roll over your 401(k) to a Roth IRA, you could have to pay taxes on the amount that you convert (or rollover). So, if you're in a high tax bracket, it may not make sense to do the conversion. You may also want to consider whether you want to keep your investments with the same company or move them to a new one. Your financial advisor will be best equipped to help you navigate these issues.
Rollover IRA vs Traditional IRA
When you leave a job, what can you do with your 401k? Basically, you have four options — you can cash it out, leave it with your old employer, roll it over into a new employer plan or into an IRA. If you're under age 59 1/2, cashing out will likely result in a 10% penalty plus taxes that will be due on the funds.
Leaving the money with your old employer may not be a great idea either, as you'll be subject to their rules, restrictions and investment options. Ask your advisor what your options are or if the best option is to roll over the 401(k) into an IRA.
Rollover Roth 401K to Roth IRA
You may be wondering if you should roll over your Roth 401(k) to a Roth IRA. Here are a few things to note:
Are you still employed by the company that sponsors your Roth 401(k)? As with any 401k, if you’re still employed, you may not be able to roll over your account.
If you are no longer employed by the company that sponsors your Roth 401(k), you may be able to do a direct rollover of your account balance to a Roth IRA. Which can make the rollover process fairly easy to complete.
You can also do a 60-day rollover, but this could mean that you will have to pay taxes on the amount rolled over if you miss the deadline. In other words, you’ll have 60-days to deposit the funds into another IRA account in order to avoid taxation and a possible penalty.
You may want to consider rolling over your Roth 401K to a Roth IRA if you are retired or plan on retiring soon.
Here again your wealth management professional is here to advise you about your unique situation.
Questions To Ask Yourself Before Rolling Over An IRA or 401(k)
What should I know before rolling over my 401(k)? Talk with your advisor and your plan administrator to find out if your plan allows rollovers. If so, you'll need to obtain and complete the proper forms (or in some cases, provide your plan with verbal instructions).
What are the advantages of rolling over a 401(k) to an IRA? There’s no one-size-fits-all here. This may vary depending on your 401(k) plan fees, options, and services. In some cases, an IRA may offer more control and flexibility over your investment options than a 401(k). If you’re over the age of 70 1/2 and have charitable intent an IRA will allow for Qualified Charitable Distributions, which as of 2022 most 401(k) plans do not.
What are the disadvantages of rolling over a 401(k) to an IRA? Usually, your employer takes care of the investments in your 401(k), but an IRA may require you to locate your own financial advisor or learn the role yourself. In addition, an employer plan may offer stronger creditor protection should you run into legal trouble.
Could I lose money in a rollover? Typically, you don't lose money in a rollover situation because you avoid having to pay taxes immediately. This is a good question to bring up with your financial advisor and/or your plan administrator, though. In some cases, there may be fees associated with transferring or closing your account.
How easy is it to rollover your retirement account? Most of the time, you just fill out the appropriate forms, which you or your financial advisor can get from your plan administrator. In some cases, your plan administrator will accept verbal instructions to rollover the funds. Most plans will move the money directly for you, but some may send you a check. You have 60 days to put that check in another retirement account or face taxes, and a potential penalty, on the money.
What are the tax implications of rolling over your account? Unless you are rolling money into a Roth IRA from another type of account, you do not pay taxes on the money. However, you may have to report the rollover on your federal tax return as a non-taxable withdrawal. In addition, you must report any money you withdrew from a retirement account for 60 days or longer. Any time you do a rollover, it's a good idea to take all the paperwork to your tax preparer before filing with the IRS.
Are there any penalties for withdrawing money from the account early? Generally speaking, yes. Most of the time you will pay a 10% federal penalty for withdrawing money from a retirement account before age 59 ½. Depending on what state you live in additional penalties may apply. There are however exceptions to the 10% early withdrawal penalty, such as first-time home buyer, death, or disability. Talk with your financial advisor or plan administrator to learn more.
What happens to your account if you die before retiring? The balance of your account transfers to your beneficiary. You should have named a person or organization (it could be your estate) as your beneficiary when you opened your account. It’s always a good idea to make sure your beneficiaries are accurate. A rollover is a great time to ensure your beneficiary plan is up to date.
Rolling over a retirement account can be as simple as completing a form — or it can create a massive headache. If you would like to talk with an investment professional give us a call. Our team at Cooke Wealth Management would love to assist you.