Understanding how retirement accounts work and using them the right way can make the difference between having a secure future or just scraping by, after you stop working. They have powerful benefits, such as cutting taxes, automating contributions, and even receiving additional matching funds from an employer.
Problem is, retirement accounts are loaded with strict rules, which can be confusing and keep you from managing them properly. Rollovers are an often-misunderstood way to avoid taxes and penalties when you need to move money from one account to another, such as after leaving a job.
Even though “doing a rollover” sounds like a cute dog trick, don’t underestimate its ability to save you some serious money on taxes. A tax-deferred rollover occurs when you withdraw cash from one retirement account and contribute it to another account within 60 days.
When handled correctly, doing a rollover is the best way to move money between retirement accounts. But when mishandled, taking money out of a retirement plan can be expensive.
When handled correctly, doing a rollover is the best way to move money between retirement accounts. But when mishandled, taking money out of a retirement plan can be expensive.
In this article, I’ll answer 10 common questions about how to use a retirement rollover correctly. You’ll learn how to avoid paying tax penalties, get more investment options, and continue building your retirement nest egg when you need to change accounts.
Question #1: What is a retirement rollover?
Answer: As I previously mentioned, a rollover is when you move some or all your money in one retirement account to another retirement account, without incurring a tax penalty. Investments in the old account are sold and then you invest the proceeds in the new account by choosing from its menu of available options.
Withdrawing funds from a retirement account, without doing a rollover, typically causes you to pay income tax plus a 10% early withdrawal penalty, if you’re younger than age 59½. So, a rollover gives you a way to move your retirement funds without triggering an expensive, taxable event.
The most common reason to rollover retirement money is after you leave a job with a retirement plan, such as a 401k or 403b. If you don’t want to leave the funds with an ex-employer, you can move them into an IRA (Individual Retirement Arrangement) that you own as an individual.
Even though it’s different than a 401(k), doing a rollover to an IRA within 60 days doesn’t trigger income tax or a penalty. Your new earnings in the account will grow tax-deferred, just like they did in your old workplace plan.
Question #2: How do you do a retirement rollover?
Answer: Let’s say you plan to leave a job with a 401k and want to move your funds to a traditional IRA. As soon as your employment ends, there are three simple steps to complete a rollover:
- Open a new traditional IRA, if you don’t already have one
- Send a transfer request to your 401k
- Choose investments for your new IRA funds
You can download a rollover request form from your online retirement account, or get one from your account custodian or the benefits administrator at work. Depending on the institution, you may have the option for funds to be sent electronically, known as a trustee-to-trustee transfer or rollover. This is the best option because you never touch the funds.
The second-best option is called a direct rollover, which is when you receive a paper check made payable to your new account. You’re responsible for forwarding it to your new institution within a strict 60-day deadline.
If you don’t contribute all the funds to a new retirement account within 60 days (including weekends and holidays), it’s considered an early withdrawal, subject to income tax plus a 10% penalty, if you’re younger than age 59½.
There’s a third option for receiving a rollover distribution that I don’t recommend: having a check made payable to you. When you receive retirement funds in your name, there’s a mandatory 20% withholding penalty applied—even if you intend to complete a rollover. This is a safeguard for the IRS, just in case you change your mind and decide to keep the cash.
For example, if you want to roll over $10,000 from your 401(k), the custodian withholds 20% for taxes and you’d only get a check made payable to you for $8,000. If you complete the rollover, you eventually receive a refund for the withholding when you file taxes.
But that could be many months away and you lose the ability to earn potential investment gains every day that you don’t control those funds. So, remember that a trustee transfer or a direct rollover is the best for your wallet.
Question #3: Can I do a retirement rollover before leaving a job?
Answer: You may have the option to take a hardship withdrawal or a loan from your workplace retirement plan while you’re still employed. Some plans may also allow for “in service” withdrawals if you’re over age 59½. But in general, you can’t do a rollover until after you leave the company, become disabled, or retire.
Question #4: Do I have to do a retirement rollover if I leave a job?
Answer: You don’t have to rollover retirement funds from an old job, but it’s typically the best choice. Here are the three other options:
- Leave funds in your former employer’s plan, if allowed
- Rollover funds to another employer’s plan, if allowed
- Cash out
Even if your old employer allows you to keep funds in their retirement plan, there’s typically a minimum balance requirement, such as $5,000, and you’re prohibited from making any new contributions. But you can manage the funds as you wish by reallocating investments and enjoying their tax-advantaged status and growth potential.
The final option for your old retirement account, cashing out, is the easiest, but worst one for your financial future.
If you go to work for another company that offers a retirement plan, most allow rollovers from another plan (but not from an IRA). This option gives you the same tax advantages and consolidates funds into one account.
The final option for your old retirement account—cashing out—is the easiest, but worst one for your financial future. As I previously mentioned, you’ll owe income tax plus an early withdrawal penalty when you’re younger than age 59½. You also give up huge amounts of potential growth and security for retirement.
Let’s say you have a balance in the account of $100,000 and decide to cash out. If you must pay 40% for federal and state tax, plus an additional 10% penalty, you lose 50%. Your $100,000 nest egg just shrunk to $50,000 in one fell swoop.
Before deciding what to do with an old workplace retirement plan, consider factors including account fees and expenses, investment choices, services offered, and the treatment of any employer stock you have. Using an IRA usually gives you many more investment choices, but may charge higher costs for certain funds compared to an employer-sponsored plan. Just be sure to choose low-cost investing funds to keep a lid on fees.
One benefit of keeping funds in a workplace plan is the legal protection provided by the Employee Retirement Income Security Act (ERISA). It gives protection from creditors, except the federal government.
That means if you got into financial trouble and couldn’t pay a creditor, they could sue you, but couldn’t take your 401k or 403b funds to repay your debt. Whether creditors can touch some or all of your retirement money in an IRA varies from state to state. So, if protecting your retirement from creditors is a concern for you, be sure to ask your existing or potential new IRA custodian about your state’s regulations.
Question #5: Can I rollover a 401k into a Roth IRA?
Answer: Since traditional retirement contributions are made on a pre-tax basis and Roth contributions are after-tax, you can only roll over workplace accounts into like accounts without triggering a tax consequence. For instance, you can roll over a traditional 401k into a traditional IRA and a Roth 401k into a Roth IRA.
Moving money from a traditional workplace account into a Roth IRA would be considered a Roth conversion, making you responsible for income tax on any amounts that weren’t previously taxed. So, I generally don’t recommend doing a Roth conversion because it can result in a huge tax liability.
Question #6: Can I combine my rollover and new contributions in the same IRA?
Answer: If you open a new IRA to facilitate a rollover, you can always add new contributions or use it for additional rollovers. If you already have an existing IRA, you can use it for a rollover, if it’s a like (traditional to traditional and Roth to Roth) account, as I mentioned earlier.
For 2018, you can contribute up to $5,500, or $6,500 if you’re over age 50 to either a traditional IRA, a Roth IRA, or to a combination of the two. Your rollover funds don’t count toward the annual IRA contribution limits.
Question #7: How often can you do a retirement rollover?
Answer: The only rollover restriction is when you move money from one IRA to another IRA, which you can only do once per year. There are no restrictions on how often you can do:
- Rollovers from a workplace plan to an IRA
- Rollovers from a workplace plan to another plan
- Rollovers from a traditional IRA to a Roth IRA, known as a Roth conversion
- Trustee-to-trustee transfers from one IRA to another IRA
So, if you request a trustee-to-trustee transfer or a direct rollover, where funds are never put in your name, there’s no limit to how often you can rollover your money.
Question #8: Do I have to report a rollover on my taxes?
Answer: When you complete a timely rollover, you’ll receive two tax forms at the end of the year. Form 1099-R shows that you took a distribution from a retirement plan and Form 5498 reports that you made a rollover contribution.
Even if no portion of your rollover is taxable, you’ll need to submit these forms with your tax return.
Question #9: Can I do a Roth rollover if I earn more than the annual limit?
Answer: Doing a retirement rollover is different than making an account contribution. So, the annual income thresholds that make high-earners ineligible to contribute to a Roth IRA don’t apply for rollovers.
For 2018, married couples filing taxes jointly are prohibited from making Roth IRA contributions when their modified adjusted gross income exceeds $199,000. Singles and heads of household who earn more than $135,000 are also ineligible.
Question #10: Can I rollover a 401k with pre- and post-tax money in it?
Answer: Most traditional workplace plans give you the option to make pre- and post-tax contributions. This might be a good idea if you max out a 401k or 403b, but still have more to invest. You would have to make the additional contributions on an after-tax basis.
You can roll over a mixed workplace plan to a traditional IRA, with the after-tax portion getting designated as non-deductible contributions. Or you could rollover the after-tax portion into a Roth IRA without triggering any tax consequences.
If you choose to maintain non-deductible contributions in a traditional IRA, make sure you report it properly using Form 8606 and discuss it with the account custodian. It’s important to keep track of the after-tax amount so you don’t pay tax on it twice when you take distributions in retirement.
The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options.
What’s the Best Place for Your Retirement Rollover?
To sum up, the best place for your old retirement account depends on the flexibility and legal protections you want, the quality of your old plan, your income, and whether you have a new retirement plan that accepts rollovers. The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options.
If you have questions about doing a rollover, go straight to your retirement plan custodian for advice. They can walk you through the process to make sure you don’t break the rules and end up with a botched rollover.
Get More Money Girl!
If you set a resolution to get out of debt this year, awesome! Now it's time to actually learn how to do it. Don't miss Laura's new online class Get Out of Debt Fast--A Proven Plan to Stay Debt-Free Forever. Enroll with an 85% discount for a limited time when you click here to learn more!
To connect on social media, you’ll find Money Girl on Facebook, Twitter, and Google+. Also, if you’re not already subscribed to the Money Girl podcast on Apple Podcasts or the Stitcher app, both are free and make sure that you’ll get each new weekly episode as soon as it’s published on the web. The show is also on the Spotify mobile app! Click here to sign up for the free Money Girl Newsletter!
Download FREE chapters of Money Girl’s Smart Moves to Grow Rich
Retirement Planning Concept image courtesy of Shutterstock
Tidak ada komentar:
Posting Komentar