Thinking about a 401k Rollover?
Changing Jobs? Recently Laid Off? Getting Ready to Retire?
Your life is changing. It’s time to consider whether your 401k plan should be changing too.
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The Retirement of the 401k
So why should you considering rolling over your 401k into an IRA or Roth IRA? With the current market conditions, 401k retirement plans continue to lose value, with very little hope for improvement in the near future. Industry averages reveal a 20-35% drop in overall 401k values over the past year. And to add insult to injury, the Spectrum Group performed a recent survey which showed that the number of employers matching 401k deposits have dropped 29% in the past 12 months. The combination of poor market trends and loss of employer deposits is causing many individuals to seek alternative methods of retirement investing.
Among the employers cutting 401k matching policies are: Rockwell Automation, J.P. Morgan Chase and surprisingly AARP, the a leading retirement services company. Companies view these type of policy changes as quick methods of cutting costs while not having to fire employees.
With the current losses, prominent analysts are estimating 401k portfolios will take 2-3 years recover from the losses reached in 2008. Which is simply too long for many investors to wait, especially without the assurance of sort of recovery.
Without the corporate matching policy in place, many workers are choosing to independently manage their retirement portfolios in Roth IRAs, which have historically better track records and decreased tax penalties.
The government is also attempting to reform the 401k procedure and create a new program designed to mitigate risk while improving on the sub par Social Security system. Several senators have been pushing for the Universal Retirement Program, which would mandate contributions from employers and employees, with the government subsidizing lower-income workers.
Lose Your Job? Rollover Your 401k Now!
With the current recession, each day more and more people are losing their jobs. And with the stress of trying to find work, many individuals forget to rollover their pre-existing 401k plans from their former employer. It is key that you take action on this process immediately, so that you won’t incur any additional financial penalties.
Here is what to do to rollover your 401k account:
1. Choose between rolling your 401k into another 401k or an IRA.
2. Open the new account, make sure to let the financial professional know that you plan to fund the account with pre-existing 401k funds.
3. Request rollover forms from your previous 401k fund director.
4. Transfer your funds directly from your old 401k plan to the new fund.
If you choose to take the funds directly for a rollover, the pre-existing 401k plan director will be forced to withhold 20% of the funds for tax purposes since they cannot be sure of your intent.
The process really is quite simple, however many IRA plan providers will take care of the entire process for you. Since they organize rollovers on a daily basis, it is preferable to utilize their services to ensure you complete the rollover with the minimal amount of penalties incurred.
401k Hardship Withdrawal
On this blog we’ve discussed the issue of taking loans from your 401k, however there are specific situations when you can take a hardship withdrawal as well. Each 401k plan has different options, however the general requirements are below:
- To rectify an immediate financial need, such as foreclosure or losing your car.
- You cannot obtain a loan by any other means (including a 401k loan).
How can the money be utilized?
- Education tuition
- Emergency loan or mortgage payments
- Primary home purchase
- Medical expenses
This action should always be a last resort considering that the penalty for a 401k hardship withdrawal can be as high as 35%. Therefore, you should only look to it as a funding option AFTER you’ve exhausted every other means of funding.
There are additional methods to retrieve funds from a 401k, even without financial hardship. However you will be taxed on the withdrawal. The methods of qualification are as follows:
- Becoming disabled
- Court orders, specifically for a divorce settlement
- You leave your job
- Medical expenses surpass 7.5% of your adjusted gross income
Why Rollover Your 401k?
The first inclination that many individuals have when leaving their job is to cash in the funds from their 401k retirement portfolio. However this decision is typically the worst choice to make, considering the harsh penalties from both taxes and the financial institutions themselves. Instead, migrating your 401k assets into a tradition or Roth IRA can produce long-term financial results with the minimal amount of penalties. Comparing that to the alternative, the chances are if you are under the age of 59 1/2 years old, it is practically guaranteed that you will get penalized for your withdrawal.
If you are planning on rolling over your 401k, the next step is to decide where you will be migrating it to. You have three main options:
1. A new 401(k) Program
2. A Traditional IRA
3. A Roth IRA
Here are the Tax implications of all three:
401k - Contributions are deposited as “tax deferred” and then taxed at normal income bracket for distributions.
Traditional IRA - Contributed money is at first post tax money. However, contributions are tax deductible which reduce your tax basis for that tax year. Then, distributions are taxed at the normal income for distributions. Tax deductibility is limited by MAGI and participation in pension or 401k.
Roth IRA - Contributions are post tax money and no taxes have to be paid under normal distributions
Here are the Contribution Limits for all three:
401k - $16.5k/yr for under 50, $22k/yr for 50 and over in 2009; limits are a total of trad 401(k) and Roth 401(k) contributions. Employee and employer combined contributions must be lesser of 100% of employee’s salary or $46k.
Traditional IRA - $5k/yr for age 49 or below; $6k/yr for age 50 or above in 2009; limits are total for trad IRA and Roth IRA contributions combined.
Roth IRA - $5k/yr for age 49 or below; $6k/yr for age 50 or above in 2009; limits are total for trad IRA and Roth IRA contributions combined.
So before you make any decision, make sure you review your options with a financial professional.
Practical 401k Rollover Instructions
The web is full of resources suggesting to rollover your 401k. However very few sites give clear guidelines on how this can be accomplished efficiently, incurring the minimal amount of penalties. Below are practical steps to rolling over your 401k into an IRA.
1. Select the financial institution you plan to migrate your investment portfolio to.
2. Thoroughly review your current 401k policies to ensure you can rollover the account.
3. Ensure that the financial institution that will be receiving the funds is properly set up to accept the funds.
4. Have the check from your current 401k program deposited in your new retirement portfolio within 60 days from the date it was sent out.
If you follow these four steps you will be able to migrate your 401k with the smallest amount of penalty possible.
So why do you need to rollover your 401k when you leave your job? Originally 401k accounts were supposed to remain active for the entirety of an employee’s life. However in 2004 a number of companies started charging a fee to ex-employees who maintained their 401k account with that company. This financial penalty made helped to create the 401k rollover process, since individuals did not wish to be charged from their former companies. So if you are in a job transition, migrating your 401k account may be a necessary process to protect your assets.
Brokerage IRAs
One of the most common times to perform a 401k Rollover is during a job or career transition. Since each corporation has a different retirement plan, many individuals take this opportunity to migrate their long-term investment portfolio into an IRA, particular the ever-increasing in popularity Roth IRA. However, many uninformed people do not take the proper steps to migrate their 401k and therefore incur numerous tax penalties. These penalties can set your retirement back by years or even cause tens of thousands of dollars to be lost completely. With this in mind it is critical to perform the 401k Rollover properly.
Here are the available methods for rolling over your 401k:
- Rollover into a new 401k
- Rollover into an IRA or Roth IRA
One great aspect of rolling over into an IRA is that the government allows individuals to migrate their retirement portfolio into a brokerage IRA. This process can take place at practically any accredited financial institution and results in the minimal amount of commission penalties. One of the most popular options for individuals rolling over into a brokerage IRA is taking advantage of Exchange Traded Funds, more commonly known as ETFs. In addition to the tradition investing options such as stock and bonds, brokerage IRA accounts also allow you the flexibility and stability of investing in CDs.
401k Loans
With life’s challenges, there are times when leveraging your retirement portfolio becomes necessary. This is never an ideal situation, considering the fact that most individuals have 401k plans to fund their retirement. However, there are certain times when borrowing against the 401k is your only option.
First, make sure that you meet with your 401k administrator, since not all 401k plans allow for loans against the portfolio.
What reasons are typically accepted by 401k plan admins?
- Medical Expenses
- 1st Time Home Buyers
- Mortgage (to prevent foreclosure)
- College Tution (this includes higher education costs for yourself, your spouse, or any of your children)
If you are looking to take a loan out for any other reasons besides the ones listed above, you may run into roadblocks.
401k Loan Guidelines
- Length of Loan - typically the loan term would be five years (60 months) or less. In the case of a home loan, terms could be as long as 15 years.
- Loan Minimum - loan minimums are typically $1,000.
- Loan Maximums - usually the lesser of 50% of the account balance or $50,000.
- Loan Fees - 401k plans can charge fees for loans including loan initiation fees and annual service charges.
- Repayment - repayment typically occurs evenly over 60 months, although as mentioned, 401k loans beyond 60 months are possible.
Since there is little risk to the bank due to the fact that you are borrowing from your own money, 401k loans usually are quick and easy to get approved. However it is always vital to understand the personal risks before contemplating borrowing for your long-term retirement portfolio.
If you don’t understand the pitfalls, it’s easy to fall into the pits! We’ll be talking more about this topic in future posts. Stay tuned!
401k Rollover Planning
The best method of completing a successful 401k Rollover is filling out all the paperwork out accurately to ensure no clerical mistakes are made. Remember that it is your responsibility to review each rollover item and you will be held accountable for the details of the transaction.
“The participant has the responsibility to read the papers and check them off,” said Trish Brambly, president of Resources for Retirement Plans “If you mess up, the former employer will issue you a check … and then it’s a big mess.”
After you have put the proper procedure in place for directing the funds, it is equally important to ensure your new account is ready to receive the cash. The best method for accomplishing this is to set up the new account prior to initiating the 401k Rollover process. You can do this by requesting the appropriate forms from your new employer. This way you will have the correct routing numbers for the transaction.
If you are rolling into another 401k, you can perform a ‘trustee-to-trustee’ transaction. In this transfer, the cash can be migrated without any taxation issues, which are the primary mitigating factors behind most 401k Rollover attempts.
If you withdraw the money directly, you only have 60 days to deposit it into a tax-deferred account before the IRS automatically assumes that you are keeping the funds for immediate use, and thus taxes it.
So pay attention - this is not something you should handle casually. If you miss the deadline and go beyond the 60 day period, you could be taxed heavily and feel very sorry later. This is obviously something that can and should be avoided at all costs!
IRA Rollovers to Assist in Economic Development
In recent posts we’ve discussed extensively the advantages of converting from a 401(k) to a Roth IRA for your retirement portfolio. And with good reason, with the combined factors of low account values and low tax rates, there has not been a better time in recent history to rollover into a Roth IRA. However this migration is not only for 401(k)s, but also for traditional IRA programs.
With the Jobs and Growth Tax Relief Reconciliation Act of 2003, Congress is using incentives to convince Americans to convert their Traditional IRA to a Roth IRA. Currently, there are approximately $18 trillion in tax-deferred pension accounts in the US, including $9 trillion in Traditional IRA money.
At a 30% tax rate, if Congress were to coax every American to convert their Traditional IRA to a Roth IRA and pay their taxes now, it could mean several trillion dollars of desperately needed tax revenues.
The accountant’s strategy for taxes is typically to defer income and accelerate expenses. This said, many experts seem to believe that with Obama’s new approach of taxing the wealthy to pay for his proposed budget, paying taxes now may be the prudent thing to do. The theory is that rolling out of the Traditional IRA and into something better would be wise because of the hyperinflationary tax hikes sure to be coming soon. In a rising tax-rate environment, it makes sense to pay the taxes now, at historically low tax rates.
Not only would this strategy assist in relieving the national financial crisis, it would also lay a firm foundation for long-term portfolio growth, since Roth IRAs allow your deposits to grow tax-free. And with the estimated tax increases that are likely to occur over the next four years, it makes sense that more people are opting to rollover in the current economic environment — hoping to lay the groundwork for future retirement portfolio growth in the years to come.
401k Rollover Rules
401k plans were created to be difficult to rollover, both for yourself and your creditors. Despite the fact that there is no instant rollover implementation, you can efficiently migrate your 401k retirement portfolio into several outlets, including the popular Roth IRA.
The reason why IRA Rollover rules are complex is due to the fact that they are held differently. “The money you have in a 401k is held in a trust for your benefit,” said Ted Benna, the creator of the first 401k plan and president of the 401k Association. “With an IRA, the ownership resides with you.”
Since it is typically your employer who holds the 401k, the trust causes the funds to not be seen by creditors as an asset to leverage. In other words, your company cannot utilize the 401k fund total in order to qualify for a business loan. This protects the fund, however it also make the process rolling over the capital complicated, much more so than an IRA.
In order to withdraw funds from the 401k, it is required that you have what is called a ‘Benefit Event’. This is typically when you officially retire, or when you move to a different company.
In order to remove the money, you need to inform your employer the amount of capital you are taking along with where you want the money to be directed. You can accomplish this with a 401k-election form. You can have the money taken out and placed into:
- Lump sum distribution
- Scheduled releases
- Rollover into a new retirement portfolio, such as an IRA
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