A retirement plan rollover – moving your savings from an employer-sponsored retirement plan to another employer’s plan or individual retirement account such as an IRA – is something you are likely to encounter at least once in your lifetime.
Rollovers of funds from a former employer’s plan are commonly used when you join a new company and consolidate the old plan with the new one in order to take advantage of employer matched contributions. Some company-sponsored plans also allow for partial “in-service” rollovers that are usually limited to 50% of the amount of the fund not to exceed $50,000. Other times, individuals choose to rollover funds from an inactive plan to an individual retirement account that can hold a wider variety of investment options (sometimes referred to as a self-directed IRA).
Handled properly, rollovers should not create unnecessary fees, taxes or penalties. Here are a few considerations when deciding to rollover an inactive retirement plan.
1. Missing the 60-day window to deposit a rollover check
There are two ways to rollover your savings when you change employers. One option is to have your plan administrator transfer the money directly into the new company-sponsored retirement plan (making the check payable to the new plan administrator or account custodian). The second option is to collect a check from your previous investment manager, and then deposit it into the new account.
If you opt for the second option, you must deposit the check into another retirement plan within sixty (60) days. If you don’t, the IRS will consider the check amount as a distribution, not a rollover, and you will owe taxes on the full amount withdrawn. And if you are younger than 59 ½ (the age at which distributions are allowed), you will also be charged an additional 10% early withdrawal penalty.
A direct transfer arranged through your plan administrator is usually the safest route, but if you do go for a rollover check, remember to move quickly to avoid unnecessary taxes and penalties.
2. Tax considerations of Roth conversions
You can rollover your old 401(k) or other retirement plan to one of two types of accounts – a Traditional IRA or a Roth IRA – both of which have benefits and tradeoffs. A Roth IRA allows your savings to grow tax-free, so that you do not owe any income taxes once you start withdrawing money in retirement. The tradeoff is that you have to fund the Roth IRA with after-tax money.
Additionally, if you rollover an old 401(k) or convert a Traditional IRA into a Roth IRA, you will be transferring pre-tax money. As a result, the funds being converted will be treated as income, claimed on that year’s income tax return and taxed at your current income tax rate. With a Roth IRA you pay taxes now which means your future distributions are tax free.
3. Multiple Traditional IRA rollovers per year
Under IRS rules you are allowed to roll over one distribution for each IRA owned per year. This rule is in place to prevent people from making multiple rollovers per year and effectively using their IRA funds as a short-term loan. Making more than one rollover in one calendar year will count as a withdrawal, triggering taxes and an early withdrawal penalty.
It’s important to note that this rule does not affect an IRA owner’s option to transfer assets from one IRA directly to another IRA of the same type.
4. Not making a rollover
Retirement is probably not something you think about every day, and it is easy to get complacent about planning for the future. But if you just leave your money in an inactive retirement plan sponsored by a previous employer, there is a good chance that higher fees, no matching contributions and limited investment choices will slow down the growth in that account.
5. Not considering a self-directed IRA
So, you’ve decided that you need to do a rollover. Now, it’s important to consider all your available investment options. One of the most tax-efficient accounts that many investors overlook is the self-directed IRA. This type of account lets you invest in a much wider range of assets such as real estate, trust deeds and promissory notes, precious metals, private funds, private equity and crowdfunded offerings. This makes it a great investment vehicle for those looking to further diversify their retirement savings portfolios to grow retirement wealth or turn wealth into income.