You have pulled the plug and retired. Hopefully retired early while still young enough to enjoy it. Now you need to do something about your 401K and any scattered IRAs that you might have. Correctly Handling Retirement Account Rollovers is essential if you want to avoid taxes and the dreaded 10% early withdrawal penalty. I have documented the basics here so you will be informed about your options and understand the benefits and pitfalls each provides.
Handling Retirement Account Rollovers – Your 401K
Your 401K – Take it or leave it. Most folks that retire will have a 401K plan at the company they have worked for. Possibly a few other 401K accounts left at their earlier employers. Most employer’s 401K plans will allow for you to leave the account within the plan. This brings up some interesting options. You will want to know how easy your access to the account will be after you leave the company. Will you have the same portal and capabilities you had as an employee? Or will you be burdened and delayed in making changes or withdrawals? Some company 401Ks are controlled by a 401K administrator who must receive a request before acting on it.
Most financial planners will say that it is always better to do a 401K rollover to an IRA. That way you will have better control, better investment choices, and lower fees. All of that is usually true but there is a consideration to throw in there.
401K Age 55 Retirement Exception
The age 55+ break. If you are age 55 or more when you retire from your employer you can make penalty free withdrawals from your 401K. Even if you have not reached age 59 ½ yet. This applies only to the last employer you worked for. Not any previous employer 401K plans you may have left in place before age 55.
If you retire and are between the ages of 55 and 59 ½ then you may want to consider leaving the 401K there. That is if you plan on using money from that account to fund your early retirement. You would only have to pay applicable taxes for any money you withdraw from the 401K. Once you do a 401K rollover to an IRA you have lost that benefit and will have the 10% early withdrawal penalty apply until age 59 ½.
401K Rollover Options
When you leave the business and want to pull out your 401K funds you have two options. A check made out to you or direct rollover made out to the trustee that you have provided. With either option you have 60 days to complete the 401K rollover (deposited) into an IRA. Missing the 60 day deadline means the entire balance is subject to the 10% penalty (except age 55 exemption) and all Federal and State Taxes. The 60 day countdown starts on the day after the check is cut. It includes weekends and holidays. But there are considerations with these two options.
Check made out to you.
If you have your 401K check written to you then the company must withhold 20% Federal Taxes. You will not be able to get that money back until you file that year’s taxes. This is a burden if you decide you want to rollover the 401K into an IRA. Because now to make the 401K rollover whole you have to come up with the withheld Tax amount out of your pocket. Otherwise the tax withholding amount (rollover shortfall) will be taxed when you file taxes. There is the possibility of it being penalized depending on your age at time of 401K distribution.
If you wanted the money and wasn’t sure you wanted to rollover any part of the balance then the 20% withholding and tax/penalty implications are just the cost of indecision.
Direct Rollover Option (a)
To avoid withheld taxes and having to makeup that amount in a rollover just go the direct rollover route. Some call this a trustee to trustee rollover. What you do is set up your IRA that you want the 401K to go to. Ask the bank or brokerage where you have this IRA for specific written instructions on how the 401K withdrawal check should be made out to them as your trustee. Example, “Wanderlust Financial Corporation, for the benefit of Your Name.” Then there will be no mandatory 20% withholding from the check and you simply get it to your IRA within the 60 day time period.
Direct Rollover Option (b)
Some 401Ks and trustee Banks/Brokerages may allow for a direct rollover by way of a wire transfer from the company 401K plan account to your rollover IRA. When this is possible it makes things much simpler because you don’t have the worry of something causing you to blow the 60-day rule. However check for any additional costs that you should be aware of before going this route.
Company Stock as part of your 401K
If your 401k account holds appreciated company stock you may want to apply this strategy to reap some tax benefits. If your company 401K retirement plan account is holding appreciated employer stock when you leave your job. Then consider withdrawing the shares and holding them in a taxable account and not rolling them into your IRA. You still have the option to rollover everything else into an IRA.
If you are closing out your 401K by taking a lump-sum distribution of which will include the shares, you are only taxed on the amount that the plan paid for the stock. That means if the stock has appreciated, you pay a lower tax based on your basis at ordinary income rates instead of the full amount. The difference between the current market value on the distribution date and the cost for the shares qualifies for the lower long-term capital gains tax rate.
Better still, capital gains tax is deferred until the shares are sold. Any additional appreciation would qualify for the lower long-term capital gains rates if the shares are held for more than 12 months before you sell them. If the shares are rolled over to an IRA, then there is no tax break and the withdrawals and shares sold will be taxed at the ordinary income tax rate once sold and withdrawn.
Handling Retirement Account Rollovers – Your IRA
Doing an IRA to IRA Rollover. Great news, there is no worrying about mandatory 20% Federal tax withholding. The check can be made out to your name when rolling over one IRA to another IRA. You still have the 60 day time period to rollover the funds. But there is also one other rule to be aware of. You can’t have any other IRA rollovers within one year (365 days) of this new distribution. All is not loss if you have multiple IRA rollovers in a given year time-frame. Just go the Direct Rollover (trustee to trustee) route. That’s because they don’t apply to the once a year IRA to IRA rollover limitation.
A Final Comment.
Usually the trustee or location where you choose to open your IRA account will be able to give you all the details and directions. Everything required to correctly complete a Retirement Account Rollover without incurring unnecessary penalty and/or taxes. If you need help be sure to get help by doing additional research and/or enlisting the assistance of a Fiduciary CFP Financial Planner. Hopefully this information has helped you understand the options and considerations for Handling Retirement Account Rollovers.