Submitted by Tim Whisler, CRPC®, CLTC®, Certified Financial Fiduciary® President of The Whisler Agency, Morton IL.
When you leave an employer to pursue another job with a new company or you are embarking upon the path of retirement, you have options for your 401(k). Shortly after leaving that employer, you will receive a large packet with pages and pages explaining the options that are available to you. Most find this packet of information like trying to take a drink of water from a fire hose. Let’s simplify the process and look at your available options. After all, you worked hard to save and sacrifice for these funds, so you do not want to make a mistake in the next step.
Option 1: Cash Out Your 401(k)
I certainly hope that you don’t find yourself in this situation, but if you would need immediate access to the funds in your 401(k), you can take an immediate distribution to be used for an emergency or other expenses. This option is generally not recommended because you will face an immediate taxable event for the amount withdrawn. In addition, if you are younger than 59-1/2, you may also incur a 10% early withdrawal penalty. Moreover, a distribution now can have a significant impact on your retirement savings, especially if you are several years away from retirement. Proceed with extreme caution before choosing this option.
Option 2: Roll Over Into Your New Employer’s 401(k)
If you are leaving ABC Inc. and taking on a new role at XYZ Inc., your new employer may offer the option to bring your 401(k) from ABC along with you. Some people find this option attractive because it simplifies their retirement accounts by consolidating them into one account. However, you will want to confirm that your new employer will allow this and you will also want to be aware if any restrictions would apply to your funds. Keep in mind that 401(k) plans offer a menu of limited investment options which also come with a variety of fees. If your new employer offers a 401(k) but doesn’t provide a matching benefit, you would certainly want to explore another option.
Option 3: Roll Over Into a Traditional IRA
Where a 401(k) plan offers limited investment options, establishing a Traditional IRA offers you an almost limitless amount of investment options. The Traditional IRA option allows you the opportunity to find a plan that will closely suit your needs as well as your tolerance for risk. In addition, you may also realize fewer account fees when selecting a Traditional IRA. Because the Traditional IRA is funded with pre-tax dollars, be sure to only roll over the pre-tax dollars from your 401(k). If your 401(k) had a portion of funds in a Roth 401(k), you want to roll over those funds into a Roth IRA. Be extremely careful not to mix these funds.
Should the rollover option appeal to you, I recommend a Direct Rollover as opposed to an Indirect Rollover. The Direct Rollover provides an efficient and direct path from the 401(k) into your Traditional IRA and allows you to skip any withholding requirements. In addition, because this is a rollover and not a distribution, this transaction would not create a taxable event.
What About a Roth IRA?
The difference between a Traditional IRA and a Roth IRA is simply how taxes are involved. The Traditional IRA is funded with pre-tax dollars whereas a Roth IRA is funded with after-tax dollars. So when it comes to distributions from the Traditional IRA, you will owe taxes on the amount of the withdrawal and the tax rate will be determined by your tax bracket in the current year. Keep in mind that your IRA is an IOU to the IRS.
Distributions from a Roth IRA are tax-free and when certain criteria are met, the gains from the growth of the Roth IRA can also be withdrawn tax-free. To contribute to a Roth IRA, you use after-tax dollars. If your desire is to convert dollars from a Traditional IRA into a Roth IRA, you will want to fully understand the impact the tax liability will have on those funds. This is especially critical when electing your Social Security benefits and planning for Medicare.
You worked hard and made sacrifices to generate these funds that will one day be used for your retirement lifestyle. Think carefully about your options so that you avoid making a mistake. Whether you are starting a new position or stepping into retirement, let’s discuss the options that will benefit you the most.
To learn more about Tim and The Whisler Agency, go to www.thewhisleragency.com. Click on Podcast to be directed to the “Whisler While You Retire” podcast. Be sure to subscribe to be notified when new episodes are available. You can reach Tim at (309) 291-0491 or by email at tim@thewhisleragency.com.
Investment advisory services are offered through Foundations Investment Advisors, LLC, an SEC Registered Investment Advisor. A Roth conversion may not be suitable for your situation. The primary goal in converting retirement assets into a Roth IRA is to reduce the future tax liability on the distributions you take in retirement, or on the distributions of your beneficiaries. The information provided is to help you determine whether or not a Roth IRA conversion may be. appropriate for your particular circumstances. Please review your retirement savings, tax, and legacy planning strategies with your legal/tax advisor to be sure a Roth IRA conversion fits into your planning strategies.