When considering the best 401k rollover options for your retirement planning, the “traditional IRA versus the Roth IRA” discussion will probably come up for you. Of course, there are many advantages to doing a 401k rollover to either a Roth IRA or a traditional IRA – the right one for you will depend on a number of different factors. The following is a simple comparison of both types of retirement savings accounts.
Why Do a 401k Rollover?
If you withdraw money or assets from your 401k, you will be subject to ordinary income tax, as this is known as a taxable event. If, however, you complete a 401k rollover to IRA, or Individual Retirement Account, you can delay paying tax on your retirement savings funds. In fact, the rollover to an IRA from your 401k will be completely tax-free if you follow the correct guidelines.
Perhaps the most common reason that people decide to do a 401k rollover is that they’re changing employers or leaving their job. If you cash out of your 401k, you may incur a significant 401k early withdrawal penalty, in addition to taxes and mandatory withholding fees. You won’t be subject to these fees if you perform a direct 401k rollover to IRA.
In addition, IRA plans provide superior tax benefits and give you a wider range of investment options than most 401k plans. You are empowered to shop around for the best rates, the lowest fees, the best customer service, without relying on your 401k plan’s pre-determined set of narrow options.
The Roth IRA
If you’re moving your funds from your 401k to Roth IRA, one of the most important factors to consider is whether you want to pay tax now or later. But how do you decide when the most financially-advantageous time to pay tax might be?
General logic and common sense may indicate that while you’re earning an income, you should pay any required tax upfront while it is easy and you have more funds available. However, you should also consider your current tax bracket and what your expected income will be upon retirement. If you believe you’ll be in a higher tax bracket later on, it might make sense to pay your taxes up front with a Roth IRA.
In addition, unlike 401k plans and other types of IRA accounts, there’s no required withdrawal age, so you can leave your funds in the Roth for as long as you like – secure in the knowledge that you won’t be hit with a big tax bill when you finally do retire. However, your account must be open for at least five years to qualify for tax-free status, so keep this in mind when performing your 401k rollover.
The Traditional IRA
Transferring your 401k account to a traditional IRA is another great option that will allow your retirement investments to achieve strong growth for the future. Anyone can open a traditional IRA account regardless of annual income, unlike the Roth, which is subject to income limits. With a traditional IRA, you contribute tax-deferred earnings, so you aren’t required to make any tax payments on your contributions up to the allowed contribution limit until you begin taking withdrawals in retirement.
This option could be very good if you’ve reached your maximum 401k contribution limit at work and want to achieve further savings through an IRA. If you have any further questions about the best 401k rollover option for you, consult a qualified financial advisor.