IRA Rollover Tips
If you are considering rolling over money from an employer plan into an IRA—or if you have been in contact with a financial professional to do so—follow these tips to decide whether an IRA rollover is right for you.
Evaluate your transfer options. You generally have four choices.
1. You can usually keep some or all your savings in your former employer’s plan (check with your benefits office to see what the company’s policy is).
- If your former employer’s plan has provided strong returns with reasonable fees, you might consider leaving your account behind. You don’t give up the right to move your account to your new 401(k) or an IRA at any time. While your money remains in your former employer’s 401(k) plan, you won’t be able to make additional contributions to the account, and you may not be able to take a loan from the plan. In addition, some employers might charge higher fees if you’re not an active employee. Further, you might not qualify to stay in your old 401(k) account: Your employer has the option of cashing out your account if the balance is less than $1,000 (minus 20 percent withholding) though it must provide for the automatic rolling over of your assets out of the plan and into an IRA if your plan balance is more than $1,000.
2. You can transfer assets to your new employer’s plan, if allowed (again, check with the benefits or human resources office).
- You should evaluate your new employer’s plan before deciding to roll your assets over. Make sure the new plan has plenty of investment choices and includes the investment options you prefer. Also check to make sure that accompanying fees aren’t too high. If you’re unhappy with the options provided by your new employer’s 401(k), you can always consider your other options. Remember, too, that even if your new employer accepts rollovers, you may have to wait until the next enrollment period, or sometimes until you’ve been on the job a full year, to move your assets.
3. You can roll over your plan assets into an IRA.
- A recommendation to roll over plan assets to an IRA rather than keeping assets in a previous employer’s plan or rolling over to a new employer’s plan should reflect consideration of various factors, the importance of which will depend on an investor’s individual needs and circumstances. Some of the factors include:
- Investment Options—An IRA often enables an investor to select from a broader range of investment options than a plan. The importance of this factor will depend in part on how satisfied the investor is with the options available under the plan under consideration. For example, an investor who is satisfied by the low-cost institutional funds available in some plans may not regard an IRA’s broader array of investments as an important factor.
- Fees and Expenses—Both plans and IRAs typically involve (i) investment-related expenses and (ii) plan or account fees. Investment-related expenses may include sales loads, commissions, the expenses of any mutual funds in which assets are invested and investment advisory fees. Plan fees typically include plan administrative fees (e.g., recordkeeping, compliance, trustee fees) and fees for services such as access to a customer service representative. In some cases, employers pay for some or all of the plan’s administrative expenses. An IRA’s account fees may include, for example, administrative, account set-up and custodial fees.
- Services —An investor may wish to consider the different levels of service available under each option. Some plans, for example, provide access to investment advice, planning tools, telephone help lines, educational materials and workshops. Similarly, IRA providers offer different levels of service, which may include full brokerage service, investment advice, distribution planning and access to securities execution online.
- Penalty-Free Withdrawals—If an employee leaves her job between age 55 and 59½, she may be able to take penalty-free withdrawals from a plan. In contrast, penalty free withdrawals generally may not be made from an IRA until age 59½. It also may be easier to borrow from a plan.
- Protection from Creditors and Legal Judgments—Generally speaking, plan assets have unlimited protection from creditors under federal law, while IRA assets are protected in bankruptcy proceedings only. State laws vary in the protection of IRA assets in lawsuits.
- Required Minimum Distributions—once an individual reaches age 70½, the rules and IRAs require the periodic withdrawal of certain minimum amounts, known as the required minimum distribution. If a person is still working at age 70½, however, he generally is not required to make required minimum distributions from his current employer’s plan. This may be advantageous for those who plan to work into their 70s.
- Employer Stock—An investor who holds significantly appreciated employer stock in a plan should consider the negative tax consequences of rolling the stock to an IRA. If employer stock is transferred in-kind to an IRA, stock appreciation will be taxed as ordinary income upon distribution. The tax advantages of retaining employer stock in a non-qualified account should be balanced with the possibility that the investor may be excessively concentrated in employer stock. It can be risky to have too much employer stock in one’s retirement account; for some investors, it may be advisable to liquidate the holdings and roll over the value to an IRA, even if it means losing long-term capital gains treatment on the stock’s appreciation.
4. You can cash out your balance.
- You can ask your plan administrator for a check—but your employer may withhold 20 percent of your account balance to prepay the tax you’ll owe. Plus, the IRS will consider your payout an early distribution, meaning you could owe the 10 percent early withdrawal penalty on top of combined federal, state and local taxes. That could total more than 50 percent of your account value.
Minimize taxes by rolling Roth to Roth and traditional to traditional.
You can roll over your retirement plan assets to an IRA, choosing either a traditional IRA or Roth IRA. No taxes are due if you roll over assets from a traditional plan to a traditional IRA, or if you roll over your contributions and earnings from a Roth plan to a Roth IRA. But if you decide to move from a traditional plan to a Roth IRA, you will have to pay taxes on the rollover amount you convert. It’s a good idea to consult with your plan administrator, as well as financial and tax professionals about the tax implications of each option.
Think twice before you do an indirect rollover.
With a direct rollover, you instruct your former employer to send your 401(k) assets directly to your new employer’s plan or to an IRA—and you never have to handle the money yourself. With an indirect rollover, you start by requesting a lump-sum distribution from your plan administrator and then take responsibility for completing the transfer. Indirect rollovers have significant tax consequences. You will not get the full amount because the plan is required to withhold 20 percent to ensure that taxes will be paid if the rollover is not completed. You must deposit the funds in an IRA within 60 days to avoid taxes on pretax contributions and earnings—and to avoid the potential of an additional 10 percent tax penalty if you are younger than 59½. If you want to defer taxes on the full amount you cashed out, you will have to add funds from another source equal to the 20 percent withheld by the plan administrator (you get the 20 percent back if you properly complete the rollover).
Be wary of “Free” or “No Fee” claims.
Competition among financial firms for IRA business is strong, and advertising about rollovers and IRA-related services is common. In some cases, the advertising can be misleading. Some firms use overly broad language in advertisements and other sales material that implies there are no fees charged to investors who have accounts with them. Even if there are no costs associated with a rollover itself, there will almost certainly be costs related to account administration, investment management or both. Don’t roll over your retirement funds solely based on the word “free.”
Realize that conflicts of interest exist.
FFEC and their registered representatives that recommend an investor roll over plan assets to an IRA may earn commissions or other fees as a result. In contrast, a recommendation that an investor leave his plan assets with his old employer or roll the assets to a plan sponsored by a new employer likely results in little or no compensation for FFEC or a registered representative. An investment adviser who recommends an investor roll over plan assets into an IRA may earn an asset-based fee as a result, but no compensation if assets are retained in the plan. Thus, a financial adviser has an economic incentive to encourage an investor to roll plan assets into an IRA that he will represent as either a commissioned-based broker or an investment adviser representative.
Compare investment options and other services.
An IRA often enables you to select from a broader range of investment options than available in an employer plan but might not offer the same options your employer plan does. Whether the IRA options are attractive will depend, in part, on how satisfied you are with the options offered by your current or new employer’s plan. Some employer plans also provide access to investment advice, planning tools, telephone help lines, educational materials and workshops. Similarly, IRA providers offer different levels of service, which may include full brokerage service, investment advice and distribution planning. If you are considering a self-directed IRA, consider the tradeoffs.
Understand fees and expenses.
Both employer-sponsored plans and IRAs involve investment-related expenses and plan or account fees. Investment-related expenses can include sales loads, commissions, the expenses of any mutual funds in which assets are invested and investment advisory fees. Plan fees can include administrative costs (recordkeeping and compliance fees, for instance) and fees for services, such as access to a customer service representative. In some cases, employers pay for some or all of the plan’s administrative expenses. IRA account fees can include administrative, account set-up and custodial fees, among others. Before making a rollover decision, know how much you are currently paying for your plan. Compare that to the fees and expenses of a new plan or IRA. For more information about 401(k) fees, see the Department of Labor’s publication, A Look at 401(k) Plan Fees. For IRA fees, ask your financial professional to provide you with information about fees and expenses, and read your account agreement and any investment prospectuses.
Engage in a thoughtful discussion with your financial or tax professional.
Don’t be shy about raising issues such as tax implications, differences in services, and fees and expenses between retirement savings alternatives. If your financial professional recommends that you sell securities in your plan or purchase securities in a newly opened IRA, ask what makes the recommendation suitable for you. As with any investment, if you don’t understand it, don’t buy it.
If you leave your job between age 55 and 59½, you may be able to take penalty-free withdrawals from an employer-sponsored plan. In contrast, penalty-free withdrawals generally are not allowed from an IRA until age 59½. Once you reach age 70½, the rules for both traditional employer plans and traditional IRAs require the periodic withdrawal of certain minimum amounts, known as the required minimum distribution (RMD). The RMD rules also apply to Roth 401(k) accounts. However, the RMD rules do not apply to Roth IRAs while the owner is alive. If you are still working at age 70½, however, you generally are not required to make required minimum distributions from your current employer’s plan. This may be advantageous for those who plan to work into their 70s.
Assess the tax implications of appreciated company stock.
Some retirement plans feature company securities (such as stocks, bonds or debentures)—and, as with earnings on other investments, any increase in their value will typically be subject to ordinary income tax when you withdraw the securities from the plan. But if you’re considering a distribution of company stock or securities when you leave the company, be aware that special IRS rules might allow you to defer paying taxes on the appreciation (which the IRS calls “net unrealized appreciation”). Consult your plan administrator and financial and tax professionals about tax scenarios related to appreciate company securities. The decision to move your retirement nest egg or stay put is an important one. In many cases, you don’t have to act immediately upon switching jobs or retiring.
These are examples of the factors that may be relevant when analyzing available options, and the list is not exhaustive. Other considerations also might apply to specific circumstances.
Take the Time to assess your options. Ask questions and do your homework to determine what is best for you.