Transferring a 401(k) to an IRA
An Individual Retirement Account, or IRA, can be an excellent way to save for retirement, but it is essential that you understand its different types and whether they offer tax-deductibility.
Ideal, you should rollover your distribution directly into an IRA to avoid additional taxes – this process is known as trustee-to-trustee rollover.
What is a 401(k) plan?
401(k) plans are employer-sponsored retirement savings accounts that enable employees to defer part of their paychecks into individual investment accounts managed by the plan provider, from which employees can choose among a range of investment options. Employers may make matching contributions as well, which often results in lower-cost investment funds due to group buying power; traditional or Roth 401(k)s differ in how taxes are treated for either type.
If you leave an employer who offers a 401(k), their HR department should issue you a check with the balance in it. Ideally, deposit this into an IRA within 60 days to avoid tax withholding and the 10% early withdrawal penalty; alternatively it might be more beneficial to leave it where it was once located and expect lower tax rates when retirement hits.
What is an IRA?
An individual retirement account (IRA) is a tax-advantaged savings plan that may be ideal if you lack access to workplace retirement plans, or wish to save more than is offered through them. An IRA could also serve as an excellent vehicle for providing tax advantages compared to individual accounts offered through employers.
Traditional IRAs allow you to deduct contributions from your taxable income, with withdrawals tax-free upon retirement. Conversely, Roth IRAs use money that has already been taxed and offer no deductions when contributing.
IRAs typically provide more investment options than their 401(k), such as mutual funds, exchange-traded funds (ETFs), individual stocks and bonds. Be wary of high fees when selecting investments to meet your retirement goals; required minimum distributions begin at age 70.5 in 2023 unless certain exceptions apply.
How do I roll over my 401(k) to an IRA?
Rolling over your 401(k) can be relatively straightforward. Select an IRA provider with investments you prefer (see Bankrate’s review of top providers), ensure it accepts direct rollovers, then contact your former employer to request distribution – your plan administrator will send you a check that includes 20% mandatory federal withholding taxes.
Your remaining funds should go toward opening an IRA of either traditional or Roth type, depending on your preferences. With traditional IRAs, contributions are deducted from taxable income before becoming tax-free until retirement time; with Roth IRAs contributions are made with post-tax dollars but withdrawals in retirement remain tax-free.
Once your money has been transferred to an IRA, invest it based on your long-term goals. If unsure, seek advice from a financial advisor for guidance; this article does not constitute tax advice and should always be discussed with a CPA or attorney prior to taking any actions based on this article.
What are the tax implications of a rollover?
When rolling over your retirement distribution from your former employer’s retirement plan into an IRA or employer plan (such as an IRA, tax-qualified 401(k) plan or government 457(b) deferred compensation plan), the rules governing its investments and access times will dictate how it’s invested and when you can access it – this may impact fees and investment options available to you as well as fees or limitations placed on you by that plan.
If your IRA or plan allows direct rollovers, then it may be possible to bypass the 60-day rule by having funds sent directly from your old retirement plan to your new IRA custodian. But indirect rollovers are more commonly practiced and harder to execute successfully.
An indirect rollover involves receiving a check that includes both your funds for rolling over, plus 20% income tax withholding, plus 60 days to deposit them all into your new account or you will owe income taxes at your ordinary income rate (plus possibly an early withdrawal penalty if under age 59 1/2). Most financial planners and retirement plan experts advise direct trustee-to-trustee transfers without passing through your hands to avoid these complications.