One of the advantages of having a 401k account is that you can save for your retirement using pretax dollars and defer paying taxes options until the money is withdrawn, when it’s likely that you’ll owe less in taxes than you would now. However, the ability to defer taxes isn’t designed to allow people to avoid paying taxes on everything they earn, which is why there are contribution limits established by the IRS. Generally speaking, though, you can contribute more money to a 401k account than you can to certain other types of IRAs.
Initial contributions to a 401k, however, are not the same as rollover contributions. Rollover options are contributions made to a new 401k or IRA when you leave a previous employer. The amount that you could contribute has already conformed to IRS limits. In a rollover situation, the contributions aren’t changing their amount, just where they reside.
There are some limits that affect your 401k rollover, however. The first is where that money is headed. If you’re placing your old employer 401k funds into a Roth IRA, for example, you will have to pay taxes on your contribution, as Roth IRAs contain money on which taxes have already been paid, rather than pretax dollars like a 401k account.
If you’re considering rolling your 401k funds into a Roth IRA, it’s a good idea to talk with your tax adviser first just so you know exactly what to expect and how much you’ll be expected to pay. Don’t make the mistake of thinking that just because you will have to pay taxes if you’re moving to a Roth IRA that a Roth IRA is a bad choice. There are plenty of individuals for whom paying taxes now is a good choice, and your tax adviser can help you determine if you are one of those people.
Another limit to rolling over your 401k into a new 401k account is that 401ks are typically accounts that you access through your employer. So long as you remain with this employer, you’re limited by this employer’s rules, charges and investment options. Your next shot at rolling over your money is the next time you change jobs. Another thing to consider is that a low 401k funds balance could limit your investment options in a new employer’s plan. If the new employer has particular investment options you want to take advantage of, it may make sense to rollover your old employer 401k account to the new employer’s retirement plan.
If you want to avoid some of these limits, you might want to consider rolling over your 401k funds into an IRA through a brokerage fund. These types of IRAs typically provide more flexibility in investment options, although this flexibility comes at a price, including trade or transaction fees and possibly commissions. Choosing mutual funds for your 401k rollover IRA account can help limit these expenses, but may limit your investment flexibility as well.
When it comes to choosing your investment strategy, the amount you pay to consult with an independent financial consultant may be money well spent – especially if you’re close to age 50 and have less time you have for your money to grow. A financial planner or consultant can help you optimize your contributions and dramatically increase your retirement saving’s earning potential.