By Bill Taber
A comfortable retirement is your reward after years of diligent working, strategizing, sacrificing—and saving. When it comes to retirement savings tools, nothing compares to a 401(k); but are you maximizing its potential?
For example, what happens to the money in your 401(k) when you switch jobs? The days of employees sticking with one company for their entire career are long gone (the average working adult changes jobs 12 times during their career), so chances are you’ll need to make a decision when your current employer becomes your former employer.
Have you considered a 401(k) rollover? On the path to a fulfilling retirement, it’s best to streamline your financial portfolio as much as possible (paying less in fees and having more investment options) while also still tailoring it to your specific situation. In order to harness the effects of compounding interest to help both generate and grow your long-term wealth, you need the ability to invest in what you know and understand.
What Is a 401(k) Rollover?
A 401(k) rollover is an option you have when you leave a company and want to transfer your investments into an individual retirement account (IRA). Normally people do this if they are leaving a company, switching to a new company, or retiring, but you can also do a 401(k) rollover into another 401(k) with a new employer.
Pros of a Rollover
The main benefits of a rollover from a 401(k) to an IRA are the following:
More options. Most 401(k) plans have a limited selection of mutual funds and bonds to invest in. IRAs offer those plus other options, such as individual stocks, exchange-traded funds, and income-producing real estate.
Lower expenses and management fees. This will vary depending on your 401(k), but having an IRA may decrease your management fees, administrative fees, and expenses related to each fund you have.
Convert from a tax-deferred account to a Roth account. Contributions to a 401(k) plan or traditional IRA are made using pre-tax dollars, which means distributions are taxed at the time of withdrawal. Rolling money from a traditional 401(k) into a Roth IRA gives you the option of paying taxes now so that you will not have any taxes due at the time of withdrawal in the future. If this is an option you are considering, you should discuss with your advisor and your tax professional to consider current and future forecasted tax rates to see which pathway makes the most sense.
Cons of a Rollover
Some potential cons of a 401(k) rollover include:
Creditor protection risks. Leaving your funds in a 401(k) might provide creditor and bankruptcy protections, which might not be the case with an IRA, depending on your state’s IRA rules.
No loan provision. Although it might be possible to get a loan from an employer-sponsored 401(k) account, you cannot from an IRA, which means the funds cannot be leveraged.
Required Minimum Distributions (RMDs)
Tax-deferred retirement plans are subject to required minimum distributions (RMDs). Taxes are due at the time of withdrawal. The SECURE Act changed the timeline for taking RMDs for both IRAs and 401(k) plans. For IRAs, anyone who reached age 70½ on or after January 1, 2020, will not be required to begin taking RMDs until April 1st of the year after they reach age 72. Failure to take RMDs at the appropriate time will result in a hefty 50% penalty on any distributions you fail to take on time.
Some 401(k) plans (but not all) allow you to leave money in the plan until you retire, effectively delaying RMDs, as long as you are still working for the employer who sponsored your 401(k) plan. If you leave any 401(k) funds in your prior employer’s account, the exception will not apply to those funds. The exception also does not apply to IRAs; if you have funds in an IRA, you must start taking RMDs when you reach the age limits regardless of when you retire.
Both IRAs and 401(k)s include a 10% penalty if you withdraw money before the age of 59½. The 10% penalty is in addition to taxes that you will owe on your distribution. There is one exception for 401(k) plans, known as the Rule of 55; if you retire at 55 or later, you can take penalty-free withdrawals from your current 401(k) sponsored retirement plan. The Rule of 55 does not apply to IRAs, nor does it apply to 401(k) plans still housed in a prior employer’s account.
How to Execute a Rollover
Thankfully, rollovers are pretty simple. Once you have chosen a bank, financial institution, or online investing platform, you contact your 401(k) plan administrator to let them know where you want your funds transferred. You can choose to do either a direct or indirect rollover. A direct transfer is generally recommended because it is the simplest form of getting money from one point to the next, and you do not have to worry about how or when to deposit funds.
You also have the option of doing an “indirect rollover,” where your employer cuts you a check and you are responsible for depositing the funds into a new tax-deferred investment account within 60 days. Your employer will be required to withhold 20% of the funds to pay taxes due (this 20% comes back to you in the form of a tax credit when you file your return). That means you will only receive a check for 80% of the value of your 401(k), and you will need to replace the 20% withheld amount from your personal funds or another source. If you fail to deposit the funds to a tax-deferred account within 60 days, the transfer will be treated as an early withdrawal and the entire amount will be subject to an additional 10% penalty.
Is a Rollover Right for You?
Wallace D. Wattles, author of The Science of Getting Rich, said, “It is essential to have good tools, but it is also essential that the tools should be used in the right way.” Your trusty 401(k) is a great retirement savings tool, but because there’s a lot of flexibility with rollover options, it can be confusing to know which path to choose. Your situation is unique, so a one-size-fits-all solution won’t work. Before you pull the trigger, it’s best to consult a financial professional.
Our TABER Asset Management team is here to answer your questions and help you evaluate your options. After getting to know you and your unique situation, we will determine if a 401(k) rollover makes sense to keep your 401(k) working for you. We’ll help you develop a personalized plan while also making sure you understand how it’s invested so you can be in tune with your money.
We’re dedicated to building relationships with our clients, walking alongside them as they navigate financial decisions and gain confidence in their plan to help them secure their financial future. I love witnessing the joy and relief on my clients’ faces when they realize they can pursue their dreams and live their ideal lifestyles. Can I help you do the same? Get started today by scheduling a 15-minute intro phone call online or reaching out to us at 515-557-1860 or firstname.lastname@example.org.
Bill Taber is President and Founder of TABER Asset Management, an independent, fiduciary wealth management firm that strives to do one thing well: manage their clients’ money by creating wealth, building wealth, growing income, and preserving capital so they can experience financial freedom. With more than four decades of experience, Bill is dedicated to building relationships with his clients and their families and walking alongside them as they navigate financial decisions. His favorite days are the ones when he gets to witness the joy and relief on his clients’ faces when they realize they can pursue their dreams and live their ideal lifestyles. Bill is known for going the extra mile, getting things done with integrity, and working with a stewardship mentality.
Bill graduated from the University of Iowa with a bachelor’s degree in business administration and fell in love with the profession when he got to help one of his first clients—his father—turn his lifetime of hard work into a dream retirement. He got his start in the industry as a corporate services representative for Bankers Trust Company and spent decades working as Assistant Vice President of E.F. Hutton & Co. and First Vice President of Principal Financial Securities. He is also a graduate of the E-Myth Worldwide Mastery Business Development Program and is Series 65 registered.
In his spare time, Bill enjoys giving back to his community and served 11 years as a member of the Board of Trustees of Broadlawns Medical Center and 14 years as a Community Representative to their Board Finance Committee. He is also one of the founding members of the Greater Des Moines Connections Mentoring Program. When he’s not working, you can often find Bill spending time with his family and participating in one of his many hobbies, which include traveling to national parks, presidential libraries, and foreign countries; gardening; reading non-fiction; and practicing yoga, Pilates, and meditation. He also loves the simple joys of listening to music, going for walks or bike rides, and watching James Bond 007 films and any movie starring his favorite actress, Meryl Streep. To learn more about Bill, connect with him on LinkedIn.