Rolling over your retirement funds into another retirement account when you leave for a new job has some definite advantages to it. You maintain control of your money and funds can stay in the account tax-free until you’re ready to use them.
To understand the benefits of rolling over, we first need to understand something about the 401(k). This is the type of retirement account most people are familiar with, because we tend to start putting something aside for retirement when we get that first full-time job.
The key point to remember here is that your 401(k) is administered by your employer. This system does have its perks. Many employers match whatever the employee saves dollar for dollar up to a certain point.
The downside to a company-managed fund is that it stops growing if and when you move on to another job. The money doesn’t go away. It just sits there until you’re ready to retire. The problem with it sitting there is that you have no control over it and may even forget it exists.
By doing a rollover, you can take your money with you when you switch jobs. You can also keep track of your progress and manage your funds more easily. There are direct and indirect rollovers.
When you leave a job for your next endeavor, the IRS gives you 60 days to rollover the money into another retirement account without incurring an early withdrawal penalty. You can roll it into another 401(k), choose to roll it over into an Individual Retirement Account (IRA) or other retirement structure.
Direct rollovers are about as simple as it gets. You leave the fund manager of your 401(k) at the company you’re leaving with instructions to transfer the funds into the new account.
Although you may choose to transfer the money to another 401(k), you could take the opportunity to look at other types of accounts as well.
One account to look at might be an IRA. The traditional IRA works just like a 401(k) except it’s not managed by the company. Your money is taxed when you take it out.
There is also the option of a Roth IRA. In this type of IRA, the money is taxed when you put it in as opposed to when you take it out. The advantage here is that taxes are generally higher with each passing year, so it can be advantageous to have your savings taxed at today’s rates.
However, unlike a traditional IRA, there are income restrictions that govern who can invest in a Roth IRA.
A direct transfer is easiest, but you do have the option of getting the money yourself and rolling it over into another retirement account within 60 days without paying a penalty. Things get a little bit complicated though.
If the employer makes out a check for you to rollover your account yourself, they must withhold 20% of the amount in the account. For example, if you had $10,000 in the account, the check would be for $8,000.
If you don’t place the full $10,000 in the new account, you could be subject to a 10% early withdrawal penalty if you’re under age 59 ½. You have to replace the full amount in your account from other sources like savings within 60 days.
You get the 20% difference back when you file your tax return.
What retirement strategies have worked well for you? Share them in the comments.
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.