Retirement Investing 101 – Know Your 401k Rollover Options

Planning for your retirement is crucial. Most Americans will not be able to rely on Social Security income alone to provide for all of their expenses or to allow them to continue to enjoy the standard of living they had before retirement. Compounding this situation, many Americans have increased medical expenses as they age. In addition, many Americans are living longer than their predecessors, making it easier for you to outlive your money if you haven’t planned well. You deserve to enjoy your retirement years, and that means planning your investments carefully.

As you may already be aware, there are a number of different types of retirement investment accounts, one of which is the 401k.  If you have a 401k plan, you probably began participating in the program through an employer.  If you’re considering a rollover, it’s likely that you’ve changed jobs and are wondering if your employer 401k needs to move on to a new “environment” as you have.  Other reasons to consider a rollover include having a 401k account that you believe isn’t performing to its full potential, or if you have multiple 401ks or retirement investment accounts and would like to consolidate those accounts to simplify management.

Moving your money from one 401k account to another qualified retirement investment plan is called a rollover.  There are essentially two different types of rollovers – direct and indirect.

Let’s discuss direct rollovers first.  In a direct rollover, your money goes from your 401k account directly into another qualified retirement investment plan.  This plan may be another 401k plan or some other type of IRA.  This transaction is sometimes called a plan to plan or trustee to trustee transfer and there are usually no taxes involved in this kind of transaction unless your money is being moved to a Roth IRA.

Because a Roth IRA grows with after tax dollars and no taxes have ever been paid on your 401k contributions, you will need to pay taxes on any money moved into a Roth IRA.  One caveat – the most common mistake made in 401k to IRA rollovers is not having the receiving IRA ready and able to accept your funds.  You can avoid this mistake by checking with the trustee of the receiving fund to be sure it’s open and eligible to receive rollover funds.

An indirect rollover is your other rollover option.  This transaction is sometimes called payment then transfer, which gives you a clue as to how the transaction goes.  You receive the proceeds from your 401k account, typically in the form of a check, which you then deposit into a new IRA.

Be aware that there are some drawbacks to this particular type of transaction.  First, you have a limited amount of time to accomplish this transaction – hold on to the money too long, for example, and not only do you lose potential interest earnings, but the IRS may classify the transaction as a disbursement and you may find yourself owing taxes and penalties.  You can avoid this risk by choosing a direct rollover or trustee to trustee transfer instead.

One final consideration with 401k rollovers is your age.  Typically, if money is rolled over from a 401k into another qualified retirement savings plan, there are no taxes or limits on age.  However, if you’re younger than 59 ½ years, it’s a good idea to check with your tax adviser or financial planner to make sure there will be no tax consequences to your rollover.  In fact, it’s a good idea to touch base with your tax adviser or financial planner before making any major financial decisions to ensure that your retirement savings remain intact and tax deferred.

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