Do I Have to Pay Taxes If I Transfer My 401k to an IRA?
If your investment funds do not incur high fees, it could make sense to stay with them and preserve your ability to take loans from it.
IRA accounts typically offer more investment options, including individual stocks, bonds, and exchange-traded funds. You also have the choice between traditional or Roth IRAs.
Taxes
Typically, rolling over assets from a qualified retirement plan (like your 401(k)) into an IRA is tax-free; however, before making your final decision it’s advisable to consult a tax advisor first.
The government sets annual contributions limits to individual retirement accounts (IRA), depending on your filing status and income level. Furthermore, starting withdrawals at age 72 is also required by government regulations.
There can be many compelling arguments for switching from your 401(k) to an IRA, but you need to proceed carefully when doing so. For instance, if you’re age 55 but not yet 59 1/2, an early withdrawal penalty of 10% may apply; to avoid this penalty you could conduct a direct rollover; in which the funds from your old plan would directly transfer into your new IRA account.
Fees
Rolling over your 401k into an IRA may incur certain fees; to maximize savings for retirement, try moving it into an account without fees – this way, more of your retirement savings is preserved.
Fees will depend on whether or not you do a direct or indirect rollover. A direct rollover sends money directly from one plan to another IRA account; with indirect rollovers, an old plan mails you a check which must then be forwarded onto your new IRA within 60 days to avoid IRS penalties.
Not only will IRA fees apply, but you should also factor in any management fees associated with your new investment portfolio. Make sure to compare costs carefully so you can make an informed decision regarding where best to put your money.
Withdrawals
Traditional 401(k) plans are funded with pre-tax dollars, so when withdrawing them you are subject to paying taxes on those funds. By contrast, individual retirement accounts (IRAs) are funded with after-tax dollars so no taxes are due when taking withdrawals from them.
If you hold company stock in your 401(k), moving it into a taxable brokerage account could help minimize taxes by taking advantage of net unrealized appreciation, or NUA. NUA refers to the difference between its original price and current value of your stock shares.
When making transfers from a 401(k), it’s also important to keep in mind your Required Minimum Distribution (RMD). If you are over RMD age, distributions must start being taken from retirement accounts immediately or face a 10% penalty. With self-employed or small business retirement accounts such as SEP-IRAs and SIMPLE IRAs however, direct rollover can help avoid penalties; however only once every twelve months (Revenue Ruling 78-406).
Rollovers
When changing jobs, individuals may wish to consider rolling over their old employer’s 401(k) into an IRA for tax-deferred savings. There should be consideration given to fees and investment options before making this decision.
Consider that an individual can only initiate one rollover per year and that IRAs typically impose higher fees than 401(k) plans.
When conducting a rollover, it’s best to have the check from your 401(k) custodian or administrator made out to the institution that will receive it – such as an IRA custodian or robo-advisor. This type of direct rollover is known as trust-to-trustee; otherwise it would be considered a distribution with mandatory 20% withholding.
Another consideration when rolling over from a 401(k) to an IRA includes company stock. You could owe capital gains taxes based on its cost basis rather than enjoying more favorable tax treatment while it was held within your 401(k).
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