Can I Move My 401k to an IRA Without Penalty?
Some people opt to convert their 401(k) plans to IRAs when changing jobs, which can offer numerous advantages including greater investment options and lower fees.
Direct rollover is when the plan administrator sends your funds directly to your new IRA custodian. Indirect rollover can be more cumbersome as your former employer must withhold 20% for taxes when sending over funds.
1. You Can Avoid Penalties for Early Withdrawals
If you withdraw or roll over before age 59 1/2 from an old employer’s plan or roll them over into another plan, taxes and an early withdrawal penalty of 10% could apply to each distribution or transfer. But by switching directly into an IRA instead, these penalties could be avoided altogether.
With direct rollover, you’ll arrange for the administrator of your old 401(k) plan to send a check directly to the custodian of your new IRA company; they will then deposit those funds directly into your account for investment as you see fit.
When selecting an IRA provider for your rollover, search for one with low account fees and a wide variety of investments. Consider opting for a robo-advisor – they offer cost-efficient management of portfolio rebalancing at reduced fees than human advisors – though be sure to compare both benefits and costs before making a definitive decision.
2. You Can Delay RMDs
RMD rules require you to begin withdrawing money from your retirement accounts after reaching a certain age; however, there are ways in which you can postpone this requirement.
One possible strategy involves rolling over account balances from former employer 401(k) plans and traditional IRAs into your current employer’s 401(k), provided it accepts rollovers. This could allow you to continue deferring taxes into the future, and could prevent needing to take the first Required Minimum Distribution at age 72.
One strategy involves pooling the RMD amounts from all your qualified retirement-savings accounts into an aggregate sum to meet your annual requirement, such as traditional, SEP and SIMPLE IRAs (but not inherited IRAs).
Retirees can reduce their taxable income further by diverting their RMDs towards charities through qualified charitable distribution (QCD). This not only supports causes they care about while offsetting your taxable income but also allows them to avoid incurring the 10% early withdrawal penalty for taking early withdrawal from an IRA account.
3. You Can Take a Loan
Feist notes that some 401(k) plans allow participants to borrow against their accounts, providing access to funds prior to retirement. But should you change jobs or be forced into early retirement, any remaining loan balance would become an early withdrawal distribution and therefore subject to taxes and penalties of 10% early withdrawal penalty unless an exception applies.
Converting to an IRA provides greater flexibility with your funds, including more investment options not offered through your new employer’s plan and avoiding a 10% penalty. Plus, consolidating all your old 401(k)s into one IRA means less fees to worry about across multiple accounts.
Keep your 401(k) with your former employer – though this may be less ideal as this means losing HR support and paying higher fees as an ex-employee. In addition, keeping it outright could hinder growth as withdrawals don’t compound over time.
4. You Can Skip the IRA
If your 401(k) investments and fees are suitable to you, rolling it over into an IRA may not be necessary; if it is done anyway, however, be mindful of any tax implications before doing so.
A key consideration in rolling over is whether or not to do it directly or indirectly. With direct rollover, your old plan will send the distribution directly into your new IRA; this way, no money ever passes through your hands and any potential tax complications are avoided.
Under an indirect rollover arrangement, your former employer will send you a check for your distribution minus 20% withholding and it is your responsibility to move this money into an IRA within 60 days. Furthermore, the rules allow this distribution money to cover unreimbursed medical expenses or health insurance premiums which may prove immensely helpful as you approach retirement.
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