A 401(k) and an IRA (individual retirement account) are retirement accounts that offer tax benefits. However, they do not work the same way. While a 401(k) is employer-sponsored, an IRA isn’t. Therefore, when you get another job, you must think of what to do with your employer-sponsored account.
Usually, four (4) options are available. First, you can rollover your funds into an IRA. Second, transfer it to the new employer’s plan (if one exists). Third, withdraw your money and pay the corresponding taxes. Lastly, if your former employer agrees, leave it with them.
If you choose the roll-over option, you should be extremely careful to avoid costly mistakes. This article explains how you can rollover your 401(k) to an individual retirement account without being penalized. You will also see some reasons why several people are choosing to roll over.
How to Roll Over Funds to an IRA from a 401(k) without Penalty
The first method of moving funds from an employer-sponsored account to an IRA is through a direct rollover. This method is simple and less risky. It involves moving funds directly from your previous plan manager to the one that will handle your IRA.
The second method involves receiving a check so you can go to the bank and receive your money in person. However, your previous employer will collect 20 percent of the total amount for taxes. So by the time you want to deposit the money in an IRA, you have to make up the rest.
This method is very risky because you can only hold funds for sixty (60) days. If you don’t deposit the money into your IRA within the time frame, it will be regarded as a withdrawal. This implies paying income tax and a penalty. You can visit https://bmogamviewpoints.com/how-to-move-a-401k-to-gold-without-penalty/ to learn more about rolling over without penalty.
Why You Should Roll Over from a 401(k) to an IRA
Below are some reasons you should rollover from your employer-sponsored plan to an individual retirement account.
Inheritance Tax Issues
When an employee dies, his or her beneficiary will receive their funds in a lump sum. This might generate inheritance and income tax problems. Although different plans have different rules, most companies distribute funds early enough to avoid paying maintenance fees for someone that doesn’t exist.
In an IRA, inheritance money also has tax implications. However, the beneficiary can decide to collect funds as a lump sum or in batches.
More Investment Options
Besides investing in mutual funds, an employer-sponsored plan does not offer other investment options. It also does not offer risk management. But with an individual retirement account, you’re spoilt for choice. You can invest in mutual funds, stocks and bonds, and ETFs.
Additionally, you can invest in real estate that generates income in your IRA. You can also hold cryptocurrency and precious metals and then sell them at any time. This is something you can’t do in a 401(k) because withdrawals and portfolio re-balancing are restricted to certain periods. You should consider reading this article if you are interested in holding precious metals in your retirement account.
Account Rules
You may not fully understand all the rules of a 401(k) because employers are permitted to tweak certain rules when setting up their plans. But an IRA is standardized. The rules are set by the IRS (Internal Revenue Service) and are the same everywhere.
A major difference between both accounts is the rule on taxes after distributions. In an IRA, you can decide that your taxes will not be withheld after taking a distribution. But in a 401(k), 20 percent of your distributions are withheld as federal taxes.
Therefore, it is better to choose an account that allows you to withhold some tax instead of getting a huge bill at once. In addition to losing a large chunk of your investment money, you may get penalties for incomplete tax payments. So, instead of waiting to be billed 20 percent of your total funds, you can choose the amount that will be withheld.
The benefit of this option is that your retirement funds will not diminish faster than necessary. Also, your money will continue to grow based on the principle of compound interest, and it will be tax-deferred.
Reduced Fees and Management Costs
Mutual funds investments attract high transaction costs. At the end of each year, you may discover that your expenses are more than your investment. This is particularly true for lower asset classes because the bigger plans that hold millions of dollars attract lower fees.
Most employees do not have huge amounts of money in their savings, so they may never benefit from these low fees. However, with an individual retirement account, you have the freedom to scout for an institution that offers lower fees. It also gives you control over what you invest in.
An IRA is not free. You still have to pay administrative and management fees. However, it is not as expensive as mutual funds that will encroach into your ROI over time.
Possibility of Opening a Roth
When you roll over a 401(k) to an IRA, you can easily switch to a Roth. If your previous employer offered a Roth 401(k), it makes it even easier for you to roll over to a Roth Individual Retirement Account.
A Roth does the opposite of traditional IRAs. You pay taxes on your contribution when it is deposited. This prevents you from paying taxes during withdrawal. You also do not need to take RMDs (required minimum distributions) as soon as you turn 72 years. You can decide not to even take it at all.
Switching to a Roth account will benefit you if you fall under the high tax bracket—you can figure out your 2023 tax brackets here. It is better to pay the price now so you won’t have to pay later, especially when your money has compounded much interest.
Furthermore, withdrawing funds from a Roth is easier if you are below the age of retirement (fifty-nine and a half years). You can withdraw your contributions without penalties. But there may be consequences if you take your investment earnings.
If you are eager to switch to a Roth account, you first need to move to a traditional individual retirement account. This will qualify you to make your desired switch. However, this switch should be done strategically to reduce your taxes during the conversion.
You can check out https://money.usnews.com/ to find out when to convert your account. Although this information is worth having, ensure you consult a professional financial advisor before doing the conversion.
The Bottom Line
If you got a new job, you should think about what to do with your 401(k) funds. This is because most employers are quick to make distributions to avoid paying maintenance fees. One of the best options available during such times is to move your funds to an IRA.
This article explained how you can rollover your funds without paying a penalty. An IRA offers many benefits such as low maintenance fees, more investment options, and the possibility of switching to a Roth account. Opening an account with an IRA service provider that offers low fees ensures that your investment earnings are not spent on settling fees.
