401k Plans and IRAs
Today, most employees have the opportunity to participate in a 401k, 403b, 457, or other retirement plan during their working years. Additionally, any employees receiving wages during the calendar year can contribute to Individual Retirement Account. Even though participation in such employer sponsored retirement plans may eliminate the deduction for IRA contributions, the tax-sheltered investment growth is a valuable benefit that makes additional contributions to an IRA worthwhile.
Whether you have one or more of these types of retirement savings plans, (the rest of this article will refer to 401k for brevity but applies to all types of employer plans) it may be beneficial to consider moving some or all of your present 401k to an IRA account before retirement in addition to at retirement.
Rollovers refer to the process of transferring your employer retirement account to an IRA that you have complete control over without any further connection to your employer. If done properly, such rollovers are always treated as tax and penalty free by the IRS.
Rollovers Upon Retiring and Leaving Employment
Even though many retirement plans permit retired employees to keep their funds in the employer’s retirement plan, it is common for employees to transfer “rollover” their accumulated 401k retirement savings to a newly established Rollover IRA Account. Such rollovers are most often done when an employee retires or leaves employment for another reason.
Rollover Types:
Traditional 401k to Traditional IRA- Money is moved directly electronically or by check. No taxes are due and any new earnings accumulate tax-free.
Roth 401k to Roth IRA- Money is moved directly electronically or by check. No taxes are due and any new earnings accumulate tax-free. Earnings are eligible for tax-free withdrawal once the IRA has been open at least five years and you are over age 59 and one-half.
Traditional 401k to Roth IRA- Taxes will be owed on the amount rolled over. Any new earnings accumulate tax-free and are eligible for tax-free withdrawal once the IRA has been open at least five years and you are over age 59 and one-half.
Rollovers While Still Employed
Many are not aware that “in-service” rollovers are also often permissible. Not all employer retirement plans allow rollovers while you are still employed and participating in their retirement plan(s), but you should make sure to know whether your employer’s retirement plan is one of the many that do permit “in-service” rollovers. When permitted, there is usually a certain age, such as age 55, that needs to be reached before a rollover is allowed.
401K plans that permit “in-service” rollovers will continue to permit additional contributions. Most plans allow this type of rollover once per year.
The Benefits of Rollovers
Investment Choices: Employer retirement plans always have a limitation on the number of available investment options to choose from for your savings. This limitation does not exist for IRA accounts. IRA investments can be selected from the entire universe of mutual funds, ETFs, stocks, and bonds, etc. Having more choices can many times improve investment performance and reduce volatility.
Fees and Expenses: Another benefit can be derived from reducing investment and administrative fees. Most employer plans (other than the federal government’s Thrift Savings Plans) have higher overall fees than IRA accounts have. Also, investments with very low internal expense can be used, such as found in many index and ETF funds. Companies, such as Vanguard and Fidelity, will act as the custodian for IRA accounts without charge for transferring and maintaining the account. It is common to save up to 1% annually on expenses within an IRA rollover account compared to the expenses incurred for a 401k account.
Consolidation, Flexibility, Withdrawals: Another advantage of an IRA account comes from the ability to consolidate any number of previous employer plan accounts into one IRA account. IRA accounts can also provide greater flexibility for meeting future financial needs.
They also offer certain penalty-free withdrawals that are not permitted in 401k plans. If other personal funds are not readily available, IRA account withdrawals will not incur any penalties if they are used to pay for certain medical expenses, higher education expenses, and first-time home purchase. When you reach age 59 and one-half you can make withdrawals without a 10% penalty that is assessed on any withdrawals prior to that age.
Charitable Giving: If you are over age 70 one-half, you can give money tax-free from an IRA, but this is not permitted with funds coming directly from employer retirement plans.
Required Minimum Distribution Considerations
Unlike the distribution requirement for traditional IRA accounts, rollovers from Roth 401k employer plan accounts to Roth IRA accounts are treated differently. Subsequent distributions from a Roth IRA are not required after age 70 and one-half. Such distributions are required for any funds left in any employer sponsored Roth 401k accounts after that age.
Professional Advice
To ascertain what is best for one’s own personal circumstances, it is advisable to seek help from a qualified professional. The planning opportunities are numerous and and the steps to complete a successful rollover be must be carefully followed to avoid unnecessary current and future taxation of your hard-earned savings.
Greg Tinaglia
Last Updated: 10/11/2019