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AdBits Episode 17 – 401(k) Plan Rollovers

AdBits Podcast

IRA Financial’s Adam Bergman Esq. explains 401(k) plan rollovers – when you can do them, where to move your money and why you should consider it.




When you contribute to a 401(k) plan at work, you put away money for retirement. That money grows in a tax-advantaged way, meaning you don’t pay taxes on any funds held in the plan. Traditional plans are funded with pretax money. Taxes are deferred until you withdraw from the plan. On the other hand, Roth 401(k) plans are funded with after-tax money. There is no immediate tax break, however all qualified distributions are tax free. But what happens to that money when you leave a job? What are your options and where should the money go. Generally, a 401(k) rollover is your best bet. Mr. Bergman explains how they work and why you should (almost) never leave your 401(k) funds at an old job.

What are Your Options?

The first thing you need to know is when you can actually move your 401(k) funds. If you have a plan at your current job, you cannot just take that money and do what you want with it. You need a triggering event. Generally, that means you reach age 59 1/2, you separate from your employer or the plan is terminated. Once you satisfy one of these requirements, you have options. The first is leaving the funds in the current plan. If you are still working there, that’s a good option, especially if you receive a match. However, once you leave a job, it’s best to take your funds with you.

Of course, you can withdraw the funds. All the money you withdraw is treated as taxable income. Plus, if you are under age 59 1/2, you will owe a 10% early withdrawal penalty. It’s a big price to pay and should only be done as a last resort.

The most common and recommended option is the 401(k) rollover. You can roll over old 401(k) funds to an IRA or to a new 401(k) plan. If you are moving to a new job that has a good plan AND they allow for rollovers, you can bring your account balance from your old job to your new one. That’s a personal choice, which is dependent on what the new plan offers and your goals.

Arguably, the best thing to do with old 401(k) funds is to roll them into an IRA. This could be an IRA you already have open, or a new one you create. The reason for this is that you, and not your employer, is in charge of the plan. You get to decide where to open the IRA and the types of investments you want to make. In fact, as you probably know if you follow the podcast, you can open a Self-Directed IRA and invest in alternative assets, like real estate. This is not an option with a workplace plan.

Direct or Indirect Rollover

There are essentially two types of rollovers: direct and indirect. A direct 401(k) rollover is the most efficient and stress-free. Your old 401(k) funds get rolled over directly from your old plan to the new IRA custodian. You never take possession of the money. Instead of being in ABC Co.’s 401(k), it’s now in John Doe’s IRA. There are no tax implications, since a direct rollover is simply moving funds from one plan to another.

On the other hand, an indirect rollover puts the money in your hands first. You have the onus to deposit the funds into the new plan (whether it’s an IRA or 401(k). There are certain responsibilities with this approach. First, 20% of the funds will be withheld for taxes. Since, the money is technically yours while it’s in your possession, you would have to pay taxes until a new retirement plan is funded.

Secondly, you have sixty (60) days to get those funds into the new plan. This is known as the 60-Day Rollover Rule. So, the funds go from your old plan to you. You can use those funds for whatever you want during those 60 days. Before that time is up, you must put those funds in your new retirement plan. If you fail to do so, all the funds that weren’t put in the new plan are treated as a taxable distribution. Therefore, a direct rollover is generally your best option, unless you need to use those funds for an emergency. Just be aware of the rollover rules and consequences of taking the money.

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