Can I Move My 401(k) to an IRA Without a Penalty?
IRAs often offer lower fees and greater investment options than 401(k) plans, so consulting a good financial advisor is key when considering whether to rollover an IRA account.
Ideally, direct rollover is your preferred approach – this requires having your distribution check made out directly to the IRA custodian and not made payable directly to yourself as otherwise it will be considered a taxable distribution subject to 20% mandatory withholding tax withholding.
1. Direct rollover
Direct rollover involves having your retirement plan administrator send your assets directly to the institution where you’ll open your new account, whether that’s traditional, Roth, SEP or SIMPLE IRAs.
The IRS allows you to move any distribution from a retirement plan into another IRA within 60 days without incurring taxes or penalties, and your money can be put towards any type of IRA (including one similar to what existed previously).
Direct rollovers typically incur minimal costs, as your former employer withholds 20% for taxes from any distributions made directly to an IRA with no withholding requirements. You still must keep track of the 60-day timeframe to deposit funds; IRAs offer more investment choices than 401(k)s which allows for diversifying investments as stated by Bankrate’s chief financial analyst.
2. Partial rollover
Partial rollovers involve moving only part of your distribution into an IRA for tax reasons. This process usually doesn’t incur taxes from the IRS if money moves between accounts with identical tax treatment (pretax to pretax such as from 401(k) to traditional IRA) but when multiple types of accounts are involved the distribution becomes taxable.
For instance, if your old employer plan offers an investment option that is hard to come by in an IRA, you might choose to keep some of it while rolling over the rest into one with more diverse investments at lower costs. A financial advisor can assist in making this determination.
When performing a partial rollover, make sure that any distribution checks from your retirement account are payable directly to your new IRA custodian, rather than directly to you. It is imperative that this be completed within 60 days or else an early withdrawal penalty of 10% could apply.
3. Partial rollover with RMD
A partial rollover occurs when only a portion of your 401(k) account is transferred into an IRA and the remainder remains with its former employer.
This method can help reduce mandatory 20% tax withholding or avoid the 60-day wait required to complete direct rollovers, as well as preserve some retirement savings in a 401(k).
As an employee of your current company, one advantage of keeping part of your 401(k) funds with them is being eligible for preferential capital-gains tax rates on any investment growth, rather than ordinary income taxes when withdrawing them in retirement. Furthermore, some employers may provide services that assist you with managing and taking required minimum distributions (RMDs) more effectively – for instance, some will allow you to use your 401(k) funds to invest in company stock – however this option may not always be available within every plan plan.
4. Partial rollover with RMD without penalty
Partial rollovers allow you to transfer some of your 401(k) funds directly from trustees into an IRA while leaving some in your company plan. You may receive either direct transfer between trustees, or indirect distribution via check, which must be deposited within 60 days.
These options can be beneficial to those dissatisfied with their employer-sponsored retirement plans in terms of fees and investment options, or who wish to bridge the gap between early retirement date (under Rule of 55) and Social Security eligibility. They also can reduce RMDs that must be taken each year which will be taxed as ordinary income.
Some may be tempted to skip an IRA in favor of simply moving their funds directly from their employer-sponsored retirement account into bank checking or savings accounts, but that can be costly mistake. Doing so treats any distribution as taxable income and could incur penalties.