401(k) Rollover

If you are leaving your current employer for any reason other than retirement, there are four options for what to do with the 401(k):

1. Cash out the 401(k)
2. Keep the 401(k)
3. Consolidate the 401(k) with the new employer’s plan
4. Rollover the 401(k) into an IRA

1 – Cash Out Your 401(k)

Cashing out a 401(k) is typically only a good option in emergencies unless you are retiring. A 401(k) is tax-deferred, so that money will be taxed when you cash it out at your current rate. In addition, there’s a 10% penalty if you cash out the account when you’re younger than 55 (if you’re not working) or 59½ (if you are working).

Unless you’re short on money, cashing out the 401(k) is generally not the best option for your finances. If you were laid off, for example, and do need the money, it’s best to take out only what you absolutely need.

However, because of the COVID-19 pandemic, the stimulus package passed by Congress waived the 10% fee for withdrawals from retirement accounts up to $100,000. The withdrawals can only be taken at no penalty if they are for coronavirus quarantine-related reasons, such as reduced hours, a layoff, or a furlough. Distributions will be considered a part of that year’s income and will be taxed, but that burden can be spread out over three years.

Even with the coronavirus pandemic in mind, borrowing money from your retirement fund is still recommended only as a last resort. Even without the 10% fee for withdrawals made by those under the age of 59½, it still reduces your retirement account’s balance and can affect future earnings.

2 – Keep Your 401(k) Where It Is

Whether or not you should keep the original 401(k) depends on several factors. If your current 401(k) account has investment options that you wouldn’t have with a different account, then it could be in your best interest to keep it as it is. If you’re moving to a new job and the new employer’s 401(k) offering is less advantageous or if they don’t offer one, that might also be best to keep it as it is.

The primary disadvantage of keeping your existing 401(k) is that you can’t make any new contributions to it.

3 & 4 – Rollover Your 401(k)

If you choose to rollover your 401(k) to a different plan, you can do so either to a different type of retirement account or to a 401(k) under the new employer (if the new employer offers a 401(k) that allows a rollover).

By rolling over the account you may be able to continue to make contributions to it. However, there are investment options with an IRA that aren’t available with a 401(k), so the more common option is typically to open a new 401(k) with a new employer if matching or other employer contributions are offered while rolling over the funds from the old 401(k) into an IRA.

An IRA is an Individual Retirement Account. There are four types of IRAs:

• Traditional IRA
• Simple IRA
• Roth IRA
• SEP IRA

IRA accounts are similar to 401(k) accounts in that they’re tax-advantaged and there’s a 10% penalty if you withdraw money from them prior to age 59½. Some types of IRAs may also be subject to your current tax rate if you take money out early as well.

An advantage to having an IRA is that a wide variety of asset types can be included:

• Stocks
• Bonds
• Mutual funds
• ETFs
• And more

The type of IRA available to you depends on your status. If you are opening the account as an individual, you can open a self-directed IRA: traditional or Roth IRA. If you’re a small business owner or if you’re self-employed, you can open a simple or SEP IRA.

Self-Directed IRA

A self-directed IRA is an IRA for an individual taxpayer. With a self-directed IRA, you are the one who will make all of the decisions regarding investments. In addition, you’ll have more options for what kinds of investments you want to include in your IRA, including tax liens, private placements, and real estate.

There are two types of self-directed IRAs: traditional and Roth IRA. These two types of IRAs are the ones to choose from if you are going to roll over the funds from a 401(k) account to an IRA. For both types of IRAs, there are income caps that limit how much higher earners can contribute annually (this does not include a rollover). The idea is to prevent high earners from benefiting more from the tax benefits of an IRA or 401(k) than those who make less.

Traditional IRA

Traditional IRA accounts are typically tax-deductible. Whatever amount you contribute to the traditional IRA decreases your taxable income by that amount. There are limits to how much you can contribute to a traditional IRA. In 2020, this was $6,000, unless you are over the age of 50, in which case you can make catch-up contributions up to $7,000 in total.

Your traditional IRA contributions are tax-deductible if your and/or your spouse are not covered by a plan at work.  If you and/or your spouse are covered by a plan at work, your deduction is tied to certain income thresholds. If you file taxes individually, that income total in 2020 is $65,000. If you’re married and filing taxes jointly, that income cap increases to $104,000. Above these income thresholds, your deduction starts getting phased out.

When you reach the age of 72, you’re required to begin taking money out of your traditional IRA. These deductions are called required minimum distributions (RMDs) and are calculated based on your life expectancy. If you don’t take out the required amount, there could be a tax penalty of up to 50%.

Prior to the passage of the SECURE Act in 2019, the age at limit for RMDs used to be 70½. Anyone who turned 70½ before the SECURE Act took effect on January 1, 2020, is still under the 70½ rule. If you were previously obligated to take out RMDs, even if you aren’t yet 72, the change to the age limit won’t affect you. In addition, there is no longer an age cap for making contributions. Even if you’re required to take RMDs, you can still contribute so long as you’re still working.

As part of the CARES Act coronavirus stimulus package, RMDs are waived for the year 2020. Because RMDs are taxed, this can help reduce your taxable income. In addition, if your retirement portfolio’s value has decreased as a result of the pandemic, you aren’t required to reduce it further through RMDs.

Roth IRA

With a Roth IRA, contributions aren’t tax-deductible. Yet some types of qualified distributions are tax-free. If you wait to withdraw money from a Roth IRA until after you retire, there is no income tax on the withdrawals. In addition, Roth IRAs don’t have RMDs, so if you are still working and don’t yet need the money, you aren’t required to start taking it out just because you have reached a certain age.

Roth IRAs have the same contribution caps as traditional IRAs. If you are under the age of 50, the annual cap is $6,000. For investors over the age of 50, it’s $7,000. There is also an income limitation that determines whether or not you can contribute up to the maximum amount allowed. In 2020, the cutoff is $124,000 for singles and $196,000 for married couples filing jointly, after which the contribution allowed is reduced.

Additionally, with a Roth IRA, because you pay the taxes on your contributions to the account, your contributions are never taxed when you withdraw them from the account. If you keep the account for five years or longer, the earnings on your contributions aren’t taxed, either.

Rolling over your 401(k) is typically the best choice. You avoid the financial penalties of cashing out the 401(k) early and you can possibly still make contributions to it. If you cash out your 401(k) before you turn 55 (if you’re not working) or 59½  (if you are working), there’s a 10% penalty on anything you take out of the account. If you cash out your 401(k) while you’re still working, you’ll be taxed on anything you take out at your current tax rate.

Rolling over the account to either an IRA or a different 401(k) allows you to possibly grow the account via contributions and to avoid financial penalties.

A 401(k) rollover is the transfer of money from an existing 401(k) account to another retirement account. What type of retirement plan account the fund’s rollover into depends on your new job circumstances. If you’re working for a new employer, that employer may offer a 401(k) with competitive investment options. If you’re self-employed or your new employer doesn’t offer a 401(k) retirement plan, you could choose instead to rollover your funds into an IRA.

There are three types of rollover:

1. Direct rollover
2. Transfer from trustee to trustee
3. Indirect rollover
• 60-day rollover

1 – Direct Rollover

A direct rollover is a transfer of funds from one retirement account directly into another plan. For example, an investor could transfer funds directly from a 401(k) account to an IRA. A direct transfer of funds doesn’t incur financial penalties and also doesn’t create a taxable event.

How Does a Direct Rollover Work?

A direct transfer involves the custodian of the original 401(k) account making a check out to the new account’s custodian, typically not to the account holder. If the account holder does receive the check with the 401(k) funds, those funds must be deposited within 60 days or it will be considered a withdrawal, incurring income taxes on the funds and possibly any applicable financial penalties.

As long as the funds are deposited into the new account within 60 days, the money will not be taxed, unless the account receiving the funds is a Roth IRA. 401(k) accounts and traditional IRAs are not taxed until the money is withdrawn, but with a Roth IRA, the money is taxed as it is deposited rather than upon withdrawal.

2 – Trustee-to-Trustee Rollover

A trustee-to-trustee rollover can only occur between IRA accounts. It’s similar to a direct rollover in that the funds are transferred directly to the new account. The trustee of the original IRA account transfers the funds to the trustee of the new account without going through the account holder.

3 – Indirect Rollover (60 Day Rollover)

An indirect rollover is a 401(k) rollover in which the money is transferred to the account holder, who then transfers it into the new qualified retirement account. With an indirect rollover, there’s a risk of incurring taxes and penalties on the funds if it’s not transferred properly. Therefore, direct rollovers are typically preferred because the money is transferred from one account to another directly without passing through the account holder first.

In an indirect rollover, the account holder has 60 days to deposit the funds into the new retirement account, whether it’s a new 401(k) or an IRA account, in order to avoid penalties and taxes. If the 60-day deadline is not met, the funds are treated as a withdrawal.

Because money deposited into a 401(k) isn’t taxed until withdrawal, income tax at your current rate would be owed on the total amount of the funds withdrawn. On top of that, if you are under the age of 59½, you could also incur the 10% early withdrawal penalty.

Why Would I Choose the 60-Day Rollover?

To many retirement savers, the 60-day rollover can seem like a ticking clock, an alarm just waiting to go off. Why would someone wait 60 days to roll over the money to the new retirement account with the risk of taxes and a possible penalty hanging over them? The 60-day rollover can work like a 60-day loan from your own retirement account.

A disadvantage of doing this is that when the account administrator writes a check to you for the amount you want to roll over, they have to withhold a percentage of that money for taxes, typically 20%. In order to not pay taxes on the amount that was withheld, you have to pay back the total amount, including what was withheld, even though you never actually received that total amount.

Can I Extend the 60 Days Rollover Limit?

The IRS does allow for extensions to the 60-day limit for rollovers, but only if you have missed the deadline due to circumstances outside of your control. For example, if the financial institution managing the new account receives the funds before the end of the 60 days, but does not deposit them due to an error on their part, you would qualify for an automatic waiver.

Depending on your employment situation, the choice between rolling over to a new 401(k) and an IRA may be made for you. If you are working for a new company that doesn’t offer a 401(k) retirement plan, an IRA may be your only option. However, if you have the choice, there are advantages to each kind of retirement account. It’s important to consult with your financial advisor to go over all of your available options before you make a final decision.

401(k) vs. IRA

An IRA is typically more flexible when it comes to what types of investments the account can hold. There are also often fewer fees associated with an IRA than with a 401(k). However, if you work for a company that offers competitive investment options for a 401(k) and also offers contribution matching, a 401(k) may end up being the better choice.

When deciding between a 401(k) and an IRA, the choice is really between whether you want your retirement plan to be through your employer or self-directed. If you choose to roll over into an IRA, you’re not entirely on your own, however. While you can choose to manage your IRA yourself, you can also work with a Financial Advisory firm to manage the IRA. This has the added benefit of having a professional manage your retirement accounts.

401(k) and IRA Fees

Retirement accounts of any kind typically have fees. These fees vary depending on the exact account and retirement plan that you have. Because of the investment limitations, an IRA is often a better choice unless the company you’re employed by offers contribution matching which obviously offset associated fees. And while there is a debate about paying fees for investments, this should be differentiated from fees you pay a professional to manage the money for you. If you have to pay fees to manage a 401K or IRA yourself, yes, you should look to pay the least fees possible.

401(k) to 401(k) Rollover

If you are working for a company that matches your 401(k) contributions, opening a new 401(k)  with the new company might be the best choice. The matching contribution is free money towards your retirement account. Even if there are fees or limitations on what kinds of investments you can have in the account, the additional funding is almost always worth it.

If the new 401(k) account qualifies, it may be possible to roll the funds over from the old employer’s 401(k) into the new employer’s 401(k). You would have to confirm with your human resource department or refer to the “plan documents” to see if the plan allows rollovers into it.

The financial benefit from a 401(k) comes from the employer contributions, which can include:

• Matching
• Non-elective contributions
• Profit-sharing

There are typically investment advantages to rolling over the funds from your old 401(k) into an IRA as 401(k) plans are usually limited to a certain set of options while IRAs may have unlimited choices. So, it’s more common to roll over into an IRA instead of to the new 401(k). The new employer contributions won’t affect any pre-existing funds transferred into the account, so many people elect an IRA instead for more control over their investment options with that account. Be sure to discuss your options with your financial advisor before making any decisions.

If your new employer does offer 401(k) contributions, it’s important to start a new 401(k) with that employer, regardless of what you decide to do with the old 401(k). The employer contributions are free money for your retirement account.

Traditional IRA vs. Roth IRA

If a 401(k) isn’t an option for you, your choice will be between the two different types of IRA that are available for 401(k) rollover. Here, too, your options may be limited depending on the type of 401(k) that you currently have. If you have a Roth 401(k), you will only be able to roll over your funds into a Roth IRA.

The primary difference between a traditional IRA and a Roth IRA is the taxes. In a traditional IRA, the contributions are typically tax-deductible and the funds in the account are not taxable until they are withdrawn. In a Roth IRA, all contributions are taxable now, but if you maintain the IRA and meet its requirements for at least five years, all funds, including any after-tax contributions and any earnings on those contributions, are all tax-free.

In addition, with a traditional IRA, there are RMDs when you retire. You’re required to withdraw a certain amount of money, whether you need it or not. With a Roth IRA, you can leave the money in the account if you don’t currently need it. You can even leave the funds in a Roth IRA to be inherited by your heirs and they would have ten years per the SECURE Act to withdraw all of the funds from it.

IRA Tax Considerations

When deciding between the two different IRA options, you should look at what your finances are now versus what you believe they will be when you retire. If you are currently in a high tax bracket and will be retiring within five years, a Roth IRA may not be the best option for you. You would be paying more in taxes and wouldn’t reach the five-year limit that would result in tax-free growth on the account.

If you’re currently in a lower tax bracket and anticipate that you’ll be in a higher bracket, later on, a Roth IRA may save you money. Choosing a Roth IRA would mean you would pay the lower tax rate you’re currently paying rather than the higher tax rate at the time you withdraw the funds.

It’s important to speak with your CPA first to determine what course of action is best for you from a tax perspective.

There is a limit of one rollover per twelve-month period, but only if you are transferring funds from one IRA to another IRA. That time limit does not apply if you are converting a traditional IRA to a Roth IRA, or if the rollover is trustee-to-trustee. The rule also doesn’t apply if you are rolling over funds from a 401(k) to either another 401(k) or to an IRA.

Traditional 401(k)

If you don’t need the funds as a temporary loan, a direct rollover is the best choice. You eliminate any risk of an error with the rollover. If you are rolling over from one 401(k) to a new 401(k), you will need to inform the account administrator for the original 401(k) of your intention to roll over the funds. The account administrator will need to know where the new 401(k) account is held so that the funds can be transferred to the new account.

Traditional IRA

If you are rolling over your 401(k) account to an IRA, you first need to choose a financial institution and open the new account. That financial institution can be:

• A bank
• An online investing platform
• A brokerage firm

You’ll need to let the 401(k) account administrator know where you have opened your IRA and any account details they will need to know so that they can send the funds to the new account.

Direct Rollover Instructions (Recommended Option)

Online Instructions:

Log into your 401(k) site and look for “Rollover 401(k)” or “IRA Rollover.” Sometimes you need to go into a section of the site labeled “distribution” or “withdrawal.” Once you find the area that allows you to rollover your 401(k) to an IRA, then make sure you do the option for a “direct rollover” to an IRA at outside institution. They will ask which institution: Charles Schwab. They may ask for Charles Schwab’s address:

Charles Schwab & Co., Inc.
P.O. Box 628290
Orlando, FL 32862-8290

Phone Instructions:

Call your 401(k) provider and instruct them to do a “direct rollover” into your IRA account at Charles Schwab. Instruct them to make the check out to “Charles Schwab & Co., Inc. FBO: (Your name) Acct# ****-****.” They will either mail the check to you or directly to Charles Schwab. Charles Schwab’s address is:

Charles Schwab & Co., Inc.
P.O. Box 628290
Orlando, FL 32862-8290

If they are unable to do it over the phone then ask them to email a PDF of their Distribution Form and then forward that to us. We will fill it out and have you sign it. Once you sign it, we will process it directly with the 401(k) company.

Roth 401(k) Rollover

Some 401(k) plans offer a Roth 401(k) option as well. If you have elected to contribute to a Roth 401(k) you might have monies in two different buckets: your 401(k) and your Roth 401(k). This is because either you contributed to both or because any matching contributions from your employer would have been deposited into a traditional 401(k).

A traditional 401(k) account is pre-tax, while a Roth 401(k) account is after-tax.

Roth 401(k) Rollover Instructions:

If you have a funds in a Roth 401(k) (like the scenario described above), it would require that you open both a traditional IRA (to rollover 401(k) funds) and a Roth IRA account  (to rollover Roth 40`(k) funds) at a financial institution when you effect a rollover. Then, you can follow the same process of instructing the company holding your 401(k) accounts to rollover the funds into your new respective IRA accounts.

The holding company will send a check either to you or directly to the custodian of your new IRA accounts. If you have both a traditional and Roth 401(k) account, there will be two checks. If they’re sent to you, then it will be your responsibility to take them to your custodian for deposit.

As always, if there are any questions, please discuss with a financial advisor.

Indirect Rollover

An indirect rollover is only recommended if you really need the money. Otherwise, a direct rollover is better. The risk of penalties and fees is high if the indirect rollover isn’t done properly. If you do want to do an indirect rollover, inform the account manager of your current 401(k) and they will provide you with a check for the amount in the 401(k) account. You would then have the 60 days to deposit it yourself into the new retirement account to avoid incurring penalties and taxes.

When it comes to 401(k) rollovers, it’s important to know which options will be the best for you financially. There are taxes and fees to take into account when you are choosing which type of retirement plan you want to roll your 401(k) funds into. Each account type has its pros and cons and while one account type may be ideal for one person, it may not be the best choice for another.

To explore all of your options and decide which is in your best financial interest, speak to a financial advisor.