One must however be aware of the difference between a rollover and a transfer. Without going for a full rollover, one can also do a transfer which will affect a mix-up of terms. There is a considerable difference between the two. In a rollover, you receive the funds on your own and henceforth it is your responsibility to deposit it into another account or plan. You have to do that before 60 days from liquidating the funds to avoid paying 10% withdrawal penalty on the amount (if your age is less than 59 ½). However, in case of a transfer, another custodian on behalf of you performs the transaction. So, in transferring, you actually directly transfer your cash from one custodian to a new custodian.
When can you perform a rollover?
- It is important to remember though that you cannot perform a rollover just anytime you want. Only in certain specific situations you will be allowed to do the switch of your 401k to an IRA. Leave of employment is the most common such situation. But if you have no plans to leave your current job any soon, your situation (such as financial hardship etc.) has to match the criteria of an exemption only under which you will be allowed a withdrawal. You may want to ask someone from the human resources or accounting department at your company about the possibilities of a rollover.
Why cash out is a poor idea?
- Cashing out your 401k can be detrimental to your financial health. To start with, you will have to pay federal and state taxes on the withdrawal. This can drum up to a very significant amount. Additionally, you will also have to pay 10% early withdrawal penalty if you are younger than 59 ½. Together, the penalty and the taxes may eat up the majority of the withdrawn amount. If you withdraw the money to build or purchase a house or to meet costs of approved higher education, you will be relieved of the penalty. You will still have to pay the taxes, though.
401k rollover into an IRA
- You would want to transfer from your current 401k plan to your new employer’s 401k plan only when the later gives you certain definite benefits such as low fees, lucrative investment options etc. If that is not the case, you should always perform a 401k rollover into an IRA. This is because a rollover to an IRA gives you access to a host of different investment opportunities.
- Once you decide to do the rollover into an IRA, you will have to choose a custodian. There are many different companies and brokerage firms who are qualified to handle your IRA. You will have to think up beforehand the nature of investments you are interested in. Different companies will offer you different investment opportunities. So you need to deal with a company that will cover the investment options you are interested in. The setup fees vary from one company to another, so you should also take that factor into account.
Must I invest?
- You may choose not to, but then you are going to lose out. Once you do the transfer, your money is going to sit in a money market account-like investment. This however is going to earn you very little interest. Therefore, you should ideally have a well thought out asset allocation plan in place. Again, the investment opportunities will depend on the company that will manage your IRA. Generally, you should look to maintain a diversified portfolio which will help to even out the risks.
- You can also choose to go for a self-directed IRA, rather than a traditional IRA. An example of such self-directed IRA is a precious metals IRA. This kind of retirement account will allow you to invest in gold stocks, Gold ETFs, gold coins and gold bullion bars, stocks and real estate, mining company investments etc. A self-directed IRA will allow you to hold physical precious metals like gold, silver, platinum as investments.
- Unlike traditional IRAs, a Roth IRA is not tax-deductible but this retirement account, created in 1997, comes with other benefits. One telling advantage is that you can withdraw the amount anytime you want without being subject to tax or penalty. However, keep this in mind that if you withdraw the amount within five years of creating the account, the interest earned in the IRA will be taxed. After five years though, you can withdraw the total amount without tax or penalty. However, the Roth IRA was created for middle class Americans and a single filer can only make a full contribution if his yearly earning does not exceed the $95,000 cap. For partial contribution, the cap is $110,000. For joint fliers, the earnings caps are $150,000 for full contribution and $160,000 for partial contribution.
Choosing the right IRA is the crucial thing when you are performing a 401k rollover into an IRA. As explained, there are many different factors involved. The first thing to determine is to whether you want to transfer the fund into an IRA or to another 401k plan (cash out is an option, but only under desperate circumstances). Once you have made your decision to switch to an IRA, then you need to assess your situation well before choosing to go for one or other type of IRA. The investment options and the tax implications differ from one type to another and you should be aware of these differences. If you are not certain, you should always employ the services of a qualified financial planner.