Des Moines Financial Planning: 401(K) Rollovers

May 29, 2013 3:09:22 PM / by Jason Shaw

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When leaving a job with which you have a 401(k), many factors influence what investment decision will be best for you. It is important to consult with a professional to fully understand your choices. If you live in Des Moines and need professional advice on 401(k) rollovers, call the specialists at Boelman Shaw Tax and Financial Planning.

When you leave a job, you are entitled to a distribution of the vested balance in your 401(k). This typically includes your own contribution and earnings on that amount and your employer's contribution and earnings that have satisfied the plan's vesting schedule.  Generally, 100% vesting happens within 3-6 years, depending upon the type of vesting schedule. Cliff vesting provides for full vesting after 3 years of service.  Graded vesting stipulates 20% vesting per year until reaching 100% after 6 years.  You will also attain 100% vesting when you reach your plan's normal retirement age.  Some plans offer faster, or even immediate, vesting.  Here are some choices you face in deciding what to do with that money if you change jobs.

Spend It

You could simply take your 401(k) money and spend it.  This is certainly attractive in the short term, but it is not likely the best long-term choice.  If you take the distribution and do not roll it into a new retirement account within 60 days, you will be taxed at the ordinary income tax rate on the entire value, minus any after-tax or Roth 401(k) contributions you have made. Additionally, you may be subject to a 10% penalty on the distribution if you are under the age of 55. It may be, however, that you simply need the money now and do not have the option of keeping it in a retirement plan.  In that case, it is possible to minimize the tax impact.  If you have both taxable and nontaxable funds in your 401(k), you can roll over just the taxable portion and keep the nontaxable portion for your immediate use.

Leave It

If you have less than $5000 vested in your 401(k), you have the option of leaving it in your employer's plan until you reach the plan's normal retirement age.  You may compare plans and find that the one you have suits your needs best.  You may also find that your plan affords rights or guarantees that you may lose by placing the money elsewhere.  This option is also helpful if you have outstanding loans that you have taken against the plan that you are not prepared to pay back right away.  If you take the money out of your existing 401(k) without paying back the loan, it will be taxed as a distribution.  You have 60 days to roll the money into a new 401(k) or IRA before the tax kicks in, but if the loan is not repaid before you close the 401(k), the employer must withhold 20% of the loan amount, and you will have to wait until tax time to recapture it.

Roll It

Your other option, of course, is to roll your existing 401(k) funds into a new retirement account, either your new employer's 401(k) or an IRA.  Here are some tips to help you decide which is best for you.

Benefits of an IRA

-More investment choices:  With an IRA, you can freely move money among any of the investment choices offered by the IRA trustee or custodian.  401(k)s offer a more limited selection of investments, usually mutual funds.

-Choice of custodians:  You may freely allocate money among different IRA custodians or trustees.  This allows you the flexibility of changing in case you are dissatisfied with the customer service or return you see and also provides the potential for added diversification.

-Flexibility in distributions:  With an IRA, the timing and amount of distributions are largely at your discretion.  The exception is that at age 70 1/2, a traditional IRA requires that you begin taking minimum distributions.  If your money is in a 401(k), your plan may place more limits on your distribution options.

-Future tax-free distributions:  You can convert your 401(k) distribution to a Roth IRA, from which future qualifying distributions will be tax-free.  You will, however, have to pay taxes on the distribution from the 401(k), minus any after-tax contributions you have made.

Benefits of a 401(k)

-Loan potential:  Many 401(k) plans offer loan provisions.  You may be able to borrow up to 50% of the rolled amount.  Generally speaking, you cannot take loans from an IRA, except in the short term, since any distributions are taxed as such only if they are not paid back within 60 days.

-Creditor protection:  Most 401(k)s are given unlimited protection from creditors under federal law.  IRAs are federally protected only in the case of bankruptcy, although individual states may offer some protection of IRAs from creditors. Speak with a qualified professional to learn how your IRA would be protected.

-Postponement of minimum required distributions:  If you continue to work and participate in your employer's 401(k) plan after you reach age 70 1/2, and you own less than 5% of the company, you can delay minimum distributions until April 1 of the year following your retirement.

-Possibility for earlier free distributions:  If your distribution includes Roth 401(k) contributions and earnings, and if your new employer's Roth 401(k) accepts rollovers, you can roll the amount into the new 401(k) without restarting the 5-year holding period required before receiving tax-free distributions.

Before choosing which option is best for you, it is also important to consider any surrender charges imposed by the employer plan or IRA, as well as any investment fees and expenses associated with the plan.  Consulting a qualified professional to fully understand your choices and all of their implications is the wisest course.

Tax and accounting services provided through Boelman Shaw & Company, LLC. Advisory services provided through BSC Capital Partners, LLC a state of Iowa registered investment advisor.


Topics: Financial Planning

Written by Jason Shaw