What is a rollover? Should I use a traditional IRA, new company 401k, or something else? These are some frequent questions you may want the answer to. Within this article, we will be giving you nine rules/guidelines to follow when deciding which option is best for you. This article is all about rollover IRA vs. traditional IRAs, and lump-sum distribution.
When transitioning to retirement or jobs you may take a portion out of your employer’s Retirement plan whether that is a 401k or some other type of employer plan. This portion of money is known as a lump-sum distribution. What should you do with this money? What does this mean for your future tax planning? For your retirement? What are the possible consequences of withdrawing?
This sum of money plays a valuable role in having an optimal retirement, so we will give you an understanding of lump-sum distribution and the aspects of having an IRA. Below we will discuss the usual questions and within these answers discuss the “rules” of IRA and rollover.
Are there any drawbacks involved when taking out a lump-sum distribution?
If not done properly, there may be taxes AND penalties. Even if done properly, is the decision in line with what is best for you and your goals for retirement??
A key point to make is when you change jobs or prepare to retire, you must decide what you need to do with the company retirement plan. Even no decision, IS A decision to keep your current plan and all its pros AND cons. We will bring some clarity to keeping your retirement plan, as is and benefits of a rollover IRA.
Some benefits of a tax-deferred rollover IRA could be a potential income stream during retirement, an increase in Investment options and simplicity by consolidating retirement assets. I have seen people actually FORGET they have something at a previous employer. Having a clear overall financial picture on one statement, can provide you and your financial advisor, easier access to making the best financial decisions.
9 Things You Need to Know Before Rolling Over Your 401k
- Using a Portion of my Distribution
You may believe using this sum of money for debts would be a best way to use the money, however, this can really hurt your retirement. Depending on your situation, withdrawals may be subject to 10% penalties AND taxes. Unfortunately, I have seen people take lump sum money from their retirement plan, pay 20%+ on taxes to pay down a 3% mortgage. Be VERY careful before taking lump sums out to pay of certain debts. The best way to really see what is right, is to have a customized retirement plan. You can run your actual scenario, to see what the best option is for you. A good plan takes into consideration, taxes, age, spending habits, longevity, and healthcare cost, just to name a few.
- I was offered a lump-sum distribution when leaving my job. What Now?
A simple option would be to not take the lump-sum distribution, just yet. Usually, you will have time to decide which of the many options may be best for you. I have seen people offered lump sum, annuity (income payouts) over their lifetime or joint lifetime, and other option. What you may be offered, may vary. Which options to take, depends on where you are financially, what you want to accomplish both near and long term, and what specific options are available for you in that plan.
- Defining a Rollover IRA
A rollover is a transfer of money from a previous employer’s retirement plan to another employer’s plan or IRA. Rollovers keep your assets (retirement money) tax deferred until you begin to withdrawal.
- How do I roll over my 401k?
First, you would need to have a place for your 401k money to go; usually this is an IRA or another 401k. Second, you contact the company that is holding your money you intend to move. Ask them, “how do I do a 401k rollover?”. Some companies are able to take instructions by phone. You give them your new IRA account number and custodian, Fidelity for example, and the address of that financial institution. What they will do, is mail a check directly to that custodian and the check will be made payable to something like this, Fidelity Investment, FBO (For the benefit of) John Smith. In some rare cases, they mail the check to you, if this happens DO NOT DEPOSIT IT, instead forward it to your new custodian that has your IRA or 401k. Some companies require you to fill out paperwork. As always, make sure you check with your financial advisor.
- What if I Need the Sum of Money? Is there a way to prevent the 10% early distribution penalty?
If you are over 55 years old and no longer with the company, you may be able to avoid the 10% early distribution penalty fee. If you roll that 401k into an IRA, you may LOSE this option. Where to take money from is one of the biggest decisions, a financial advisor can help you with.
- Another option is a 72t distribution.
Under Internal Revenue Code Section 72(t), your payments will not be subject to a 10% early withdrawal penalty if you take your money out in “substantially equal payments” based on life expectancy tables. The IRS has approved three different calculation methods, which results in varying levels of payments. However, except under limited circumstances, a tax penalty will apply if you change the amount or stop payments before the greater of five years or the amount of time before you turn age 59½. In other words, you must continue the payments for the longer of the two periods.
- Most Cost-Efficient Plan
Plans provided by your employer or IRAs can implement fees and expenses. A well-known option that is more accessible and cost-efficient would be a 401(k). This can differ based on the specific IRA you have available to you. Comparing and contrasting between your available options will be valuable in implementing the most affordable and effective option for you.
- The Cost of Taking Money Out Now
As mentioned in using your money for expenses any money you take out can come with a hefty price, especially on your taxes. This chart from MFS Fund Distributors is a, “cost breakdown of distribution options an annual growth rate of 6%”.
|Taking money now||Directly rolling over distribution|
|20% withholding tax||($4,000)||$0|
|10% early withdraw penalty||($2,000)||$0|
|2% additional current tax owed||($400)||$0|
|Available for reinvestment||$13,600||$20,000|
|Net value in 10 years*||$22,365||$24,356|
|Net value in 20 years*||$36,778||$43,617|
|Net value in 30 years*||$60,481||$89,598|
- What are the next steps?
As you can see, there are many things to consider when rolling a 401k. Which option is right for you depends on a variety of factors. Take a look at your overall picture and consider each option thoroughly. Always feel free to contact me at Riverbend Wealth Management if you have any questions.
Related Article: Options For Your 401(k) When Leaving Your Job
Jeremy Finger, CFP®, CIMA®, CRPC®, CPFA
Founder & CEO
Wealth Management Advisor
The Riverbend Wealth Management Team
MFS Heritage Planning – Retirement an IRA Dilemma.” MFS Fund Distributors https://www.mfs.com/content/dam/mfsenterprise/mfscom/heritageplanning/infosheets/hp_retroll_flye.pdf
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