Six Key Factors for a 401(k) to IRA Rollover
If you're contemplating the important financial decision of transferring assets from your 401(k) plan to a traditional Individual Retirement Account (IRA), it's essential to tread carefully. On the surface, such rollovers often seem straightforward—merely a matter of moving funds from one account to another.
However, the process is fraught with intricate rules, potential tax implications, and a variety of strategic considerations that could significantly impact your long-term financial planning.
Whether you're changing jobs, retiring, or simply looking for more investment flexibility, a rollover might be beneficial, but it's not without its potential pitfalls. In this guide, we'll dive into six key aspects that you must consider to ensure that your rollover serves your financial objectives, protects your assets, and optimizes your tax situation.
1. Evaluate the Benefits and Drawbacks
Before taking any action, it's crucial to scrutinize the merits and downsides of initiating a rollover. Keeping your funds in your 401(k) remains an option if your account balance is above $5,000. Also, a job transition might allow you to consolidate your old 401(k) into your new employer’s plan.
- IRAs frequently present a broader array of investment options along with more lenient withdrawal policies.
- In contrast, 401(k) accounts often have robust creditor protection under federal law, provided they are covered by ERISA.
2. Check Rollover Eligibility
Remember, not all 401(k) disbursements can be transitioned to an IRA. Ineligible distributions include Required Minimum Distributions (RMDs), hardship withdrawals, and certain types of periodic payments. Failure to account for this may result in complications, like an excess contribution.
3. Choose Direct Rollovers Over 60-Day Rollovers
The prospect of a short-term loan might be appealing, but opting for a direct, trustee-to-trustee rollover is generally wiser. When you receive the funds directly, the plan must withhold 20% for taxes. If you wish to roll the full amount into an IRA later, you'll need to supplement the withheld 20% from other resources, complicating the process.
4. Factor In the 10% Early Withdrawal Penalty
Distributions from a 401(k) before age 59½ usually incur a 10% early withdrawal fee. However, a special clause allows for penalty-free withdrawals if you leave your job in or after the year you turn 55 (or 50 for certain public safety employees). Keep in mind, this provision doesn’t extend to IRAs.
5. Don’t Overlook Net Unrealized Appreciation (NUA)
If your 401(k) includes employer stock that has appreciated, transferring this stock to an IRA could be detrimental. NUA rules let you pay ordinary income tax only on the stock's original purchase price, while any appreciation qualifies for more favorable long-term capital gains treatment.
6. Considerations for Roth 401(k) to Roth IRA Transfers
If your Roth 401(k) hasn't met the five-year criteria for tax-free withdrawals, be cautious. Moving these assets into a Roth IRA will reset the five-year countdown, irrespective of how long the funds were in the 401(k).
By familiarizing yourself with these critical aspects, you'll be better equipped to decide if a 401(k) rollover aligns with your financial objectives. Always consult with a financial advisor for tailored advice.
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.
The McBeath Financial Group team utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference.
Krista's Amazon best-selling book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.