What Should You Do With Your Old 401(k)? A Rollover IRA Has Its Advantages

FinanceWealth-Building

  • Author Bruce Stroup
  • Published November 12, 2010
  • Word count 1,049

If you have changed jobs several times during the course of your career, you probably have an interesting collection of retirement savings accounts from your previous employers. In fact, according to the Department of Labor, Americans move to a new employer once every four years and our collective trail of old 401(k) and 403(b) plans totals in the trillions of dollars.

While leaving your retirement account with a former employer is a better decision than cashing out your account and splurging on a boat, it may be more beneficial to consolidate your retirement savings by rolling your old 401(k) or similar employer sponsored retirement plan into an IRA.

A Rollover IRA offers you four major benefits:

• Increased Investment Options. The biggest advantage of rolling over your 401(k) into an IRA is the wider universe of investment choices, a benefit that’s more valuable to you if the choices in your old 401(k) plan are limited or performing poorly. Most employer-sponsored retirement savings plans offer a choice of several mutual funds and/or company stock. However, with an IRA you can invest in mutual funds, stocks, bonds, and even non-traditional retirement investing options such as real estate and venture capital.

What’s more, if you keep your rollover IRA separate from other IRAs you may own, and if you qualify to open a Roth IRA, you can decide to convert the traditional rollover IRA to a Roth IRA where future earnings on the account are income tax free. Note that whether you qualify for the Roth IRA conversion depends upon your annual modified adjusted gross income.

• Easier Record Keeping and Account Maintenance. There’s no question receiving 401(k) statements from various employers makes it difficult to monitor what you own and ensure each investment is playing the role you intended in your portfolio. It’s also more challenging to guard against harmful portfolio overlap where, for example, two funds from different investment companies could own many of the same securities. By consolidating your retirement accounts into a Rollover IRA, you facilitate the process of reviewing and rebalancing your portfolio. And, of course, you gain this greater convenience and control without tax consequences or other penalties.

• Greater access. If, for example, your previous employer changes 401(k) providers, your plan assets will be temporarily unavailable to you due to a "blackout" period that occurs as funds are transferred from one plan provider to the other. That time frame can stretch from a few days to a few months. In addition, you can tap your IRA penalty-free before age 59 ½ for the purchase of a first home or college expenses.

• Flexible Estate Planning. IRAs also offer more freedom, as well as the potential for tax savings, in the estate planning department. If you want to name multiple beneficiaries or a charitable organization as your beneficiary, that is best done with an IRA. Many employer-sponsored plans do not accommodate sophisticated beneficiary designations.

An IRA also affords your heirs more flexibility. For example, if you have named a non-spouse as the beneficiary of your 401(k) plan, it is likely that your former company’s plan administrator will insist that the account be cashed out immediately, resulting in a potentially larger tax bill and loss of the benefits of ongoing tax deferral. With an IRA, you can designate a younger non-spouse as your beneficiary and that individual can stretch out the minimum withdrawals over his or her lifetime.

Also, when your assets are invested in an IRA, your beneficiaries can get the information they need easily, rather than tracking down your former employers and completing multiple forms.

Ironically, while a Rollover IRA certainly increases your flexibility in terms of investment options and planning for the future, the rules governing the rollover are anything but flexible. And if you don’t play by the rules, you could face an unexpected tax bill.

Generally, when you take a distribution from a 401(k) plan that you intend to rollover, you must contribute it back into another IRA or other tax-deferred retirement plan within 60 days. If you do not rollover the funds within 60 days, the distribution is taxable. Also, in most cases, a 10% penalty for early withdrawal applies if you are younger than 59 ½ years of age.

To keep it simple and avoid careless mistakes, a direct rollover, also referred to as a trustee-to-trustee rollover, is often a better choice than cashing out and receiving a check from your former employer. With a direct rollover, your current plan sends a check not to you, but to the firm that serves as the custodian for your new IRA.

Plan sponsors are required to withhold 20% of the proceeds from your 401(k) as prepayment of federal income taxes if you ask your plan for a check. If you eventually roll over these assets, you will have to make up the 20% that was withheld by your plan sponsor or that amount will be taxed as income and could be subject to an early withdrawal penalty.

Note that it is possible to petition the Internal Revenue Service (IRS) to extend the 60-day re-investment rule in certain circumstances, particularly if you need time to correct errors made by financial institutions or time to deal with health issues or family problems. However, if you first consult with your financial advisor, you can be confident that your IRA rollover will go smoothly -- and that you’ll enjoy the benefits of your Rollover IRA for years to come.

The above material was prepared by PEAK.

Bruce W. Stroup, LUTCF, MA, is an investment consultant with Retirement Solutions in San Antonio. For more information on Retirement Solutions and how it can help you plan for retirement, please call (210) 424-2400.

Registered Representative of and securities, advisory services and insurance offered through INVEST Financial Corporation (INVEST), member FINRA/SIPC, a registered investment advisor and its affiliated insurance companies. INVEST is not affiliated with Retirement Solutions. This newsletter has been provided by PEAK for use by Bruce W. Stroup. All expressions of opinion reflect the opinions of PEAK and not necessarily those of Retirement Solutions or INVEST. The information contained in this newsletter is general in nature and should not be construed as tax or investment advice. INVEST does not provide tax advice. Please consult your tax advisor for guidance on your particular situation.

Bruce W. Stroup, LUTCF, MA, is an investment consultant with Retirement Solutions in San Antonio. For more information on Retirement Solutions and how it can help you plan for retirement, please call (210) 424-2400.

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