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What is a 401k Rollover?

Changing Jobs? Consider a 401k Rollover.

Unfortunately, these tough economic times have brought about significant layoffs at companies throughout the country. If you’ve been affected by a layoff or are simply considering a job change, you may be wondering what will happen to the money you’ve saved in your employer-sponsored retirement plan. With several options available to you, how do you know which is the right one?

When you leave an employer, you have several options:

 
Cash out. According to human resources services firm Hewitt Associates, 45 percent of employees cash out of their 401(k) plans when they change jobs. If you happen to be in need of cash, this option can look awfully appealing. By receiving a lump-sum payout, you’re free to spend your 401(k) dollars on whatever you like. However, in most cases, this option is the most harmful to your retirement savings. While cashing out gives you immediate access to your money, you not only sacrifice the tax-deferred growth that those 401(k) dollars
could have achieved, you also subject yourself to some substantial tax payments. By withdrawing the money before you turn age 59 ½ , you subject yourself to a 10 percent early withdrawal penalty in addition to the withholding of 20 percent federal income tax by your former employer (some exceptions to the 10 percent penalty may apply, most notably if the participant is age 55 or older at the time of termination of employment). Is having the money immediately so important to you so as to potentially sabotage your long-term retirement savings? Most likely not. Fortunately, there are other options available that will allow you to preserve the tax-deferred growth of your assets.

 Leave your money in the existing account. If your balance exceeds $5,000, plan providers are required to allow you to keep your money in your 401(k) account even after you’ve left the company. This is a simple option, because it requires no action on your part and avoids the penalties associated with taking a cash payout. Leaving your funds in a 401(k) plan may also offer benefits such as low fees and discounts on investment-related expenses due to the large size of the
plan. However, despite the simplicity of this option, the disadvantages may outweigh the advantages.

First of all, you won’t be able to contribute any additional dollars to your old plan. And, by leaving your money in your previous employer’s 401(k), you limit your investment options to those available through the plan and must rely on your former employer to manage your 401(k) account. The company you’ve left may make changes to their plan that could adversely affect your account, and if your old company suddenly goes bankrupt or merges with a competitor, things could get even more complicated. Some plans even assess an annual fee to terminated participants. Finally, leaving your money in your previous employer’s plan makes it easy to forget about it, especially if you decide to participate in your next employer’s 401(k) plan. You would also be responsible for furnishing address changes or beneficiaries to each plan as they occur. It’s not uncommon for frequent job changers to have money in several different 401(k) plans, and in many cases those funds are invested in vehicles that may conflict with each other or contradict your overall investment plan. By having all of your retirement investments in one place, it is easier to ensure that each investment is part of a properly balanced portfolio.

 
Move your money to your new employer’s 401(k). If your new employer offers a 401(k) plan, moving your money to your new employer’s plan protects you from the penalties associated with taking a cash payout. The ability to make future contributions also makes this option generally more appealing than leaving your money in your previous employer’s 401(k). However, the viability of this option
depends on the attractiveness of your new employer’s 401(k). Does your new employer’s 401(k) offer varied investment options consistent with your needs? It is important to thoroughly evaluate the options in your new employer’s 401(k) plan and decide whether or not its offerings are sufficient to help you pursue your retirement goals and are consistent with your personal investing philosophy.

Rollover your 401k money into an IRA. For many investors, a rollover into an IRA is the best option, as it offers significantly more flexibility. First of all, by rolling retirement dollars into an IRA, investors can choose from a much wider variety of funds than simply the limited number of options available through a 401(k) plan.

The rollover may be combined with other retirement dollars as well. For example, if you have worked at multiple jobs and have several 401(k) accounts, you can use a rollover to consolidate them into a single IRA account. And once you’ve
established a rollover IRA, you can continue making contributions to it in the future. The 2009 contribution limit for IRAs is $5,000. However, for individuals age 50 or older, the contribution limit is $6,000.

For those investors whose 401(k) holdings are heavily weighted with shares of employer stock, an IRA rollover provides an excellent opportunity for diversification. If your plan remains in shares of employer stock, you could potentially save a significant amount in taxes by making a Net Unrealized Appreciation (NUA) election. With this election, shares are distributed from the plan “in kind” and just the basis of the stock will be taxed as ordinary income at the time of distribution. The appreciation will not be taxed until you
liquidate the shares and will be taxed at the capital gains rate. This could save you a substantial amount on taxes if your stock is highly appreciated and you are in a high tax bracket.

And of course, an IRA rollover shields you from the taxes and penalties associated with a direct payout. With a rollover IRA, you don’t pay taxes until you begin withdrawing money.

Once you’ve completed the IRA rollover, it’s important to familiarize yourself with its characteristics, which are the same as those of a traditional IRA. With a traditional IRA, there is no earned income ceiling for eligibility to contribute. Your contributions may be tax-deductible depending on active participant status in an employer-sponsored retirement plan, so if you decide to contribute to your new employer’s plan after performing the rollover, it may affect your ability to deduct any future IRA contributions. Contributions are not allowed after the IRA holder reaches age 70 ½ , and required minimum distributions must begin at age 70 ½ . Distributions are generally taxable to the IRA holder or beneficiaries at ordinary income rates.

If you qualify, you may find that a Roth IRA is better for your personal situation. A Roth IRA is a unique investment opportunity due to its tax-free advantages. With the Roth IRA, contributions to the plan are not deductible, but distributions can be withdrawn tax-free under certain conditions. Ordinary income tax is due on the amount converted in the year of conversion. For some, paying the tax up-front can offer significant tax savings later.

 Avoiding Penalties in a  401k Rollover

Under a provision in the Pension Protection Act of 2006, distributions from qualified retirement plans can now be directly rolled into Roth IRA accounts. Previously, only traditional IRAs were allowed to convert to Roth IRAs and
qualified retirement plan assets were first rolled into traditional IRAs and then converted. Note that ordinary income tax will be due on any pre-tax dollars converted. Also, only individuals (including married couples) with adjusted gross income of $100,000 or less are eligible for Roth IRA conversions. However, this income restriction will be eliminated for conversions in 2010 and beyond.

 Avoiding Penalties in a 401k Rollover

The key to avoiding the 20 percent withholding penalty is arranging for a direct rollover. This is also known as a “trustee-to-trustee” transfer. This means that the distribution check from your previous employer’s retirement plan must be made payable to the custodian of the IRA account or the new employer’s retirement plan in which you wish to transfer the funds for the rollover. If performing an IRA rollover, your Financial Advisor can provide you with specific instructions for the check.

The next step is to contact your former employer’s retirement plan administrator to provide notice that you will be making a direct rollover and give instructions on how the distribution check should be made out and to whom it should be sent. If you receive a check made payable to you, as opposed to the custodian of the IRA or your new employer’s retirement plan, you will have 60 days to deposit it in your rollover IRA or new employer’s 401(k) plan.

 The Next Step

If you’re in the process of changing jobs or retiring, your
Financial Advisor can explain your rollover options in greater detail and help you select the one that makes the most sense for your unique circumstances. Stifel Nicolaus does not provide tax advice; therefore, you should also consult with your tax advisor regarding your particular situation.

 A valuable benefit to a Stifel IRA rollover is having the opportunity to work with a full-service investment firm. By getting to know you, your current financial situation, and future goals, an investment professional can offer a wide range of other investment products and services, such as financial planning, wealth preservation strategies, insurance, or funding a college savings plan for a loved one.

What is a 401k Rollover? Find answers now. For more Information order a 401k Rollover Kit today!