When starting a new job, the paperwork feels never-ending. Your employer needs answers about insurance, benefits, stock options, beneficiaries, etc. Among those decisions, you likely have the chance to take automatic deductions from your paycheck for a 401(k). The great thing about this is that you’re saving for retirement without thinking about it!
But at some point in your career, you may find it beneficial to move money out of that 401(k). That’s where a rollover comes in. Here’s what a 401(k) rollover is and a few fun facts on how you can make the most of one.
What’s a 401(k) Rollover?
A 401(k) rollover refers to the process of transferring funds from a 401(k) into another investment account, like an IRA.
The most common need for a 401(k) rollover is when you leave or change jobs. Typically, when you leave an employer, you need to do something with the funds in your 401(k) account.
If you’re switching to a new employer, you may be able to transfer the funds to your new workplace plan. If your new employer doesn’t offer a plan or you’re leaving the workforce for good, you can roll the funds into an IRA. Assuming you put the money into another pre-tax account, you don’t pay taxes on the transfer.
Pro tip: To avoid tax penalties, a rollover must be from institution to institution–think 401(k) to IRA custodian. If you receive a check in your name, you have a limited time to deposit it in the new account (usually 60 days). Plus, many custodians require you to withhold taxes, meaning you’d have to make up for the withheld funds out of your own pocket. We highly recommend working with a professional to avoid costly mistakes during the rollover process.
Rollovers are helpful tools for consolidating your retirement accounts and streamlining your investment strategy. In other words, keeping track of your retirement savings is much easier when there are fewer accounts to manage.
While rollovers are most common once you leave a job, there are other times where they make sense.
Fun Fact #1: You Can Rollover Funds While Working
You don’t always have to wait until you leave a job to transfer funds from your 401(k). Many employer-sponsored retirement plans will allow you to do an in-service 401(k) rollover to an IRA.
Benefits of In-Service Rollovers
There are several reasons why you might decide to do an in-service rollover.
First, a 401(k) has a limited investment menu. You can only invest in what your employer decides to offer. Some employers may have a wide array of investment options, while others give you no choice.
Rolling your savings into an IRA creates virtually endless investment options—ETFs, mutual funds, individual stocks, etc.
An IRA gives you more control over your investments, allowing you to manage them in a more hands-on way. In addition, you may find that an IRA offers lower fees than your 401(k). With reduced investment fees, more of your money goes towards your retirement savings instead of administrative costs.
Who Is Eligible?
Eligibility depends entirely on your plan. Some don’t allow in-service rollovers, while others may limit eligibility to those over 59.5. You might have a holding minimum, meaning the account must be open for a certain number of years before a rollover can happen.
The best thing to do is check your plan documents or reach out to your plan sponsor to determine the requirements or restrictions.
Considerations for In-Service Rollovers
Some 401(k) plans allow participants to take a loan from their account. IRAs, however, don’t allow users to do this.
If you plan on taking distributions early, a 401(k) allows for penalty-free withdrawals as early as 55 (as long as you meet the requirements). By comparison, the earliest age you can withdraw without penalty from an IRA is 59.5 (while there are some exceptions, they’re much more complex and niche).
And check with your plan sponsor, as some plans won’t allow you to contribute to your 401(k) after you’ve made an in-service rollover. Of course, if you no longer plan on contributing to the account, this won’t be a problem.
Fun Fact #2: You Could Catch a (Tax) Break On Company Stock
If you use your retirement plan to invest in company stock, your distributions in retirement would be taxed as ordinary income. But, there may be a way to help your company stock get preferential treatment, and it’s called net unrealized appreciation (NUA).
NUA allows participants to convert the unrealized gains from ordinary income tax to capital gains tax, although you’ll still owe some ordinary income tax.
To take advantage of the NUA rules, the stock within the retirement plan needs to be distributed as a lump sum after a triggering event—such as turning 59.5.
You must distribute the entire account, although you can choose to roll over the funds to different accounts, like an IRA or brokerage account.
NUAs are complicated, and they require advanced tax planning knowledge. If you’re considering this, reach out to a financial partner and tax expert to better understand your potential tax obligations.
Fun Fact #3: Have A Roth 401(k)? You Can Rollover To a Roth IRA Tax-Free
If you have a Roth 401(k) and are leaving your job, you can roll the funds into a Roth IRA. This is an especially effective way for high earners to keep growing their after-tax Roth dollars.
A Roth IRA normally has income ceiling limits, meaning those who earn more than a certain amount (listed below) are not eligible to contribute directly to a Roth IRA. However, rolling over funds from a Roth 401(k) to a Roth IRA means bypassing both income and contribution limits.
As a reminder, the Roth IRA modified AGI limits for 2022 are:
- $214,000 for married filing jointly
- $144,000 for single, head of household, or married filing jointly
If married filers earn between $204,000 and $214,000, they can contribute a reduced amount. The same goes for single filers earning between $129,000 and $144,000.
And total contributions (not including rollovers) are $6,000 or $7,000 for those 50 or older.
Bypassing these limits is a considerable tax advantage for high earners preparing for retirement.
You can also choose to roll over a part of your traditional 401(k) into a Roth IRA. If you take this route, just keep in mind that you will be responsible for paying ordinary income tax on the conversion.
When Does a 401(k) Rollover Make Sense?
As we mentioned above, there are a couple of scenarios in which it makes sense to do a 401(k) rollover:
- If you’re leaving a job and need to move the funds into a new plan.
- If you want more investment options.
- If you have extensive company stock within your 401(k) plan.
While this isn’t an exhaustive list, we’ve found that these are the three most common opportunities for a rollover.
Rollovers often come with multiple considerations, so check with your financial advisor before deciding on a specific retirement savings strategy.
It’s also important to consider the tax implications or parameters set by your plan sponsor.
Considering a 401(k) Rollover? We’re Here to Help
Our team is well-versed in helping medical professionals, and other high earners understand their retirement savings options. If you’re leaving your current employer or looking to bring more flexibility to your investment lineup, we’re happy to take a look.
Feel free to reach out to our team today to learn more about how we can help.
Partners in Financial Planning provides tax-focused, comprehensive, fee-only financial planning and investment management services. With locations in Salem, Virginia and Charleston, South Carolina, our team is well-equipped to serve clients both locally and nationally with over 100 years of combined experience and knowledge in financial services.
To learn more, visit https://partnersinfinancialplanning.com