So you leave your job and don’t know what to do about the money you contributed to a 401K. Do you leave it behind? Do you cash out and RUN? Or do you roll it over into an IRA? Ok, say if you make the RIGHT decision and decide to roll the funds over into an IRA, how do you go about doing that? I’ll tell you, most people know it’s best to rollover their 401k funds but DON’T because they don’t know how to do it. Instead, they keep their money with their old employer’s program and accrue maintenance fees (which generally aren’t too bad…but still!) and it limits what you can invest in (e.g. individual stocks).
In September of 2011 I moved from one company to another and I was VERY proactive in taking my money with me! I started my rollover process about 30 days after leaving and was quickly informed I did not have access to the funds until 60 days after separation.
1. Know your old employer’s guidelines of accessing your funds. Do they have a “waiting period” before you can access your money? What is it?
60 days?? Ok, no problem. With the holidays and the transition of a new job, I honestly lost track of my deadline coming and going and of rolling over the funds! So here we are in July, 8 months later and I’m JUST now getting to it (grrr!).
Now, I’m looking at the best choice for me that will grant me enough options to put together a well-diversified portfolio, and will keep the cost low.
2. Educate yourself on the bank/brokerage firm you decide to put your money in. Look at their fund composition. Do they charge a fee? What are the new guidelines for the brokerage firm you need to know (e.g. opening a new account).
After doing my research, I decided to stay with the brokerage firm I used with my 401k after noting there are no fees and they have an array of various mutual funds that I can EASILY complete a diversified portfolio. On top of that, the account set up is easy, especially since I’m a current user!
Next thing on the agenda is to determine how I’m going to rollover the funds. My choice will determine if I have a tax liability at the end of 2012, or if I will pay at retirement.
Option 1: Rollover to a Traditional IRA: Traditional IRAs are tax deferred retirement accounts which means the money you contribute is pre-tax! This is good news for you now because it limits your tax liability at the present. Rolling your 401k funds into a traditional IRA will continue the tax benefits where you are not subject to pay taxes now, BUT when it is time for you to withdraw money at retirement you will pay taxes on the withdrawn amount based on your tax bracket at that time. For many people this option sounds great because they believe their tax bracket will be lower (since they are not earning an income) than it is presently.
I’m generally not an advocate of a Traditional IRA because I believe my tax bracket will be higher at retirement due to all the investments and income I will generate from it. My outlook is I’m only going to go higher from here!
Option 2: Rollover to a Roth IRA: Roth IRAs are not tax deferred which means you contribute to this account with money that has been taxed already (post-tax). So, if you decide to rollover your 401k into a Roth IRA, be prepared to pay taxes on the withdrawn amount…this year! Example: say if you have a 401k balance of $50,000 and your tax bracket is 25%, which means at the end of this year you will have a tax liability of $12,500. Sounds scary, I know…but wait!
The thing I like about this account is money earned is tax-free as long as you keep it in the account until you reach eligibility for withdraw at age 59 1/2. This is REALLY good news…think about it, if you continue to invest over many years, all the interest you earned will be eligible for withdrawal tax-free!
3. Make a decision on how you will rollover your funds based on your unique situation. Do you think your tax bracket will increase at retirement? Are you ready to foot the tax bill at the end of the current year?
4. Speak with a qualified representative at the financial institution if you need additional guidance! Never be afraid to ask for help! I’d rather you ask now then allow 25 years to go by and you have regrets because you didn’t fully understand.
Something to Note:
When you are in the rollover process, be sure it is a direct rollover or trustee-to-trustee transfer where a check is made directly to the new brokerage firm of your choice and not placed in your name. If by chance you receive a check for your 401k funds, you have 60 days to transfer the money into a qualified retirement account, otherwise the IRS will view the funds as ordinary income and you will not only be taxed at your current tax rate but you will also get hit with the 10% withdraw penalty (if under the age of 59 ½). Please note: if the funds are sent to you in a check, you will automatically be subject to a 20% tax withholding.
Also, rollovers do not go towards your annual limit for contributing to a Roth IRA (currently $5,000/year if you are under age 50).
My next topic will discuss how to allocate your funds, taking a close look at measuring your risk, date you expect to begin withdrawing, and how aggressive (or conservative) you should be in your investment choices.
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