What to Know Before You Start an IRA Rollover

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When you have money in a company-sponsored retirement plan like a 401(k) plan, 457 plan, or 403(b) plan when your employment ends, you have the option of moving your retirement money directly to an IRA account. This is called an "IRA rollover."

Here is what you need to know before you start an IRA rollover.

Know the Difference: IRA Distribution vs IRA Rollover

If you take your retirement money as a cash distribution, you will have to pay income taxes, and if you are not yet age 59 1/2, your distribution will be subject to a 10% early-withdrawal penalty.

If you use an IRA rollover to move your retirement money from your company 401(k) directly to an IRA account, no such taxes will be assessed. Instead, your retirement money will remain tax deferred, and you will not pay taxes until you take a cash distribution.

Learn the Steps Needed to Start an IRA Rollover

1. Choose a financial institution where you want to open your IRA account. If you already have an IRA, you can roll over your company retirement money into your existing IRA. Call the company where you have an IRA, or where you would like to open your IRA account, and tell them what you would like to do. They will offer guidance.

2. Call your company retirement plan's phone number. Tell them you are no longer employed and that you would like to rollover your retirement money to your IRA account. They will most likely send you a packet of paperwork you will need to complete. Sometimes they will be able to assist you over the phone.

3. Get help if you don’t know how to complete the paperwork. After-tax money can be rolled directly to a Roth IRA. Roth 401(k) money should be rolled to a Roth IRA account. Regular tax-deferred contributions can be rolled over to a regular IRA account. If you complete the paperwork or the IRA rollover transaction incorrectly it can cause big problems later. Ask an accountant, a fee-only financial advisor, or the financial institution that is the home of your IRA account for help.

Decide Whether You Should Use an IRA Rollover or Leave the Money Where It Is

If you are between age 55 or older, think twice before you roll over retirement money to an IRA. You may have the option to take penalty-free withdrawals if you left employment after age 55.

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Know the Advantages of an IRA Rollover

1. More control over the investments. Within your 401(k) plan or other company plan, a set number of investment choices are provided for you, and the company may change plan providers at any time.

2. Potentially lower costs. The funds inside your company plans charge fees in the form of an expense ratio. You can choose similar-quality investments with lower fees by using index funds in an IRA rollover account.

3. IRAs may make things easier on beneficiaries. Not all company retirement plans offer the same rules as to how your beneficiary can withdraw funds. In an IRA account, your beneficiary will have the option to take distributions out slowly over their life expectancy. They may or may not have this option if the money stays in the company plan.

4. Ability to choose safe investments. Company retirement plans do not usually offer a wide selection of ultra-safe investments, like government bonds, certificates of deposit, and fixed annuities. If you want to have no risk, you may have more choices by rolling your money to an IRA.

Avoid Mistakes

Your retirement money is creditor-protected and tax-deferred. You do not want to lose these attractive advantages. Learn everything you can about how to avoid making costly mistakes. If you get stuck, seek the assistance of a good financial advisor.

Article Sources

  1. Internal Revenue Service. "Retirement Topics Tax on Early Distributions."