Can I Withdraw My 401(k) and Transfer it to an IRA?
A 401(k) plan enables employees to invest tax-deferred, yet money must be withdrawn before certain age limits or else it incurs taxes and penalties. An alternative solution would be rolling over these funds into an IRA which generally offers greater investment options and reduced fees.
IRS requirements stipulate 401(k) withdrawals are taken at age 73 (75 beginning 2023) and any distribution is taxable and may incur an early-withdrawal penalty of 10%.
401(k)s are tax-advantaged savings accounts
At present, about 60 million Americans invest in 401(k) plans with assets totaling $12.5 trillion in these accounts. Many employers offer matching contributions, which provide additional motivation for saving. On average, an individual has more than $20,000 saved up in one of these 401(k) accounts and cannot withdraw it before age 59 1/2 without incurring penalties.
Traditional and Roth 401(k)s provide similar savings incentives, though their respective ways of encouraging savings differ in regards to pre-tax contributions, deferring taxes until withdrawal in retirement, and tax-deferred growth of investments until you withdraw them from the account.
Roth 401(k)s allow after-tax contributions with no taxes due on withdrawals and allow funds to be withdrawn for certain medical expenses, such as hospital bills or prescriptions, without incurring taxes on them. Money taken out before age 65 is taxed, though, so please consult a financial advisor before withdrawing funds from your 401(k).
They come in two flavors: Traditional and Roth
Both flavors share the goal of encouraging people to save more for retirement; they just do so differently. Traditional 401(k)s defer taxes until you begin taking distributions at retirement; withdrawals then are taxed at ordinary income tax rates.
Roth 401(k)s work differently; by taxing contributions upfront, tax-free withdrawals in retirement are guaranteed and you’re protected against potential future changes to tax brackets.
If you are transitioning from a Traditional 401(k) to an IRA, the first thing to do is secure two checks; one for each money type. They should be made payable directly to your new IRA custodian rather than you. Be careful when endorsing them and contact a financial advisor for guidance in this process. Additionally, double-check with former employers that their accounts remain active – frozen accounts could delay access.
They have age-based withdrawal restrictions
Withdrawals made before age 59.5 will be subject to ordinary income tax and a 10% penalty, which could amount to as much as $2,400 depending on your tax bracket for every $10,000 withdrawal you make – in addition to losing out on future growth potential.
Roll over your 401(k) into an IRA to avoid penalties, which has several additional advantages such as tax-free distributions for education expenses – an increasingly popular means of funding tuition costs.
After leaving an employer plan, another way to avoid penalties is by rolling over your 401(k). Simply send a distribution request from your former plan administrator directly to the new one – either electronically or with a physical check that must be deposited yourself within 60 days.
They can be rolled over to an IRA
Rollover options can make switching employers easier, but be wary when planning how to handle taxes when doing so – you will owe ordinary income tax on any withdrawal from an IRA account; working with a financial advisor on this strategy may help alleviate stress during this transitional process.
Employers may offer special incentives to entice employees to transfer their investments, such as one-time cash bonuses or free stock trades. You should shop around for the right IRA provider as fees can eat away at returns over time.
Direct transfers are the ideal method for rolling over. Your old employer will send a check that can be directly transferred into your new IRA within 60 days or the distribution will become taxable. Write “direct rollover” on the check and mark Box 7 (Distribution Code). If there is an amount listed in Box 2, leave that box unchecked.
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