IRA Rollover – Frequently
Asked Questions about IRA Rollovers
1) What is an IRA Rollover?
IRA is a tax specialized account designed to receive funds rolled
over from a 401(k) to a self-managed Individual Retirement Account
(IRA). Rollover funds can also be derived from 403b, 457 plans and
other profit sharing plans. The IRA allows funds in to grow tax-free
and penalty free when rolled over until withdrawn during retirement.
2) When is the best time for an IRA Rollover?
The best time to do an IRA rollover is when changing
employers or jobs. This question is faced by millions of Americans
when they change jobs, what will they do with their 401(k) account
left with their old employers? One option is to leave the money
in the old employer’s plan and let it grow tax-deferred until
retirement; however most employees would like to move their 401(k)
accounts to where they are going because who knows what will happen
to a company after they lay you off or if you quit? In such circumstances,
an IRA rollover is the best option. It is the best option because
if you do a direct rollover (trustee to trustee transfer), you will
avoid the 20% withholding penalty imposed by the IRS as well as
a 10% early withdrawal penalty if you take the cash with you and
do not move it to another retirement account, such as the IRA itself.
3) Is there a limit on the amount that can be
No there is no limit when you rollover funds
from a 401k to an IRA. Therefore, it doesn’t matter if you
rollover $100,000 or $1 million, you can still rollover the full
amount. Also, having one IRA rollover is better than managing several
retirement plans after a job change. Also, an IRA offers many more
investment choices than an employer sponsored 401k plan that could
only offer employer stock and not a diverse set of investments.
For instance, Fidelity offers 4600 mutual funds rated 4- and 5-
star by Morningstar1 which is a whole lot more choices than what
a 401k plan can ever offer.
4) What happens if I take Cash when I leave my
If you take cash when you leave your old employer
instead of doing an IRA rollover, your employer will withhold 20%
of your funds (yes you will only get 80% of your money) and submit
it to the IRS. Thus, if you have $100,000 in your 401(k) that is
made payable to you in a check, your employer will withhold $20,000
for remittance to the government. Thus, in order to bring your balance
up to $100,000 in your new account, you will have to pay from your
own pocket, an additional $20,000 within 60 days of receiving the
distribution. The IRS will then return the $20,000 owed to you when
you file your tax return upon correct completion of your rollover.
What makes this worse is that the $100,000 will be included in your
W-2 IRS form as income. Also, a 10% early withdrawal penalty will
be levied in the next April 15 because you will have taken a premature
early distribution from your retirement account.
Note: The IRS is very strict on this 60 day distribution rule and
there are no exceptions.
5) How do I avoid the 20% withholding tax?
The best way to avoid the 20% withholding tax
is to do a direct IRA rollover (also known as a trustee to trustee
transfer). With this type of rollover, the money goes directly from
your 401k plan into another tax-deferred account, either an Individual
Retirement Account (IRA) or your new employer’s 401(k) plan,
403(b) plan or 457 plan. 403(b) plans are generally for teachers,
educators and non-profit employees while 457 plans are offered by
local state governments. With a direct 401k rollover, you do not
have to pay any taxes on the money when it comes out of your old
employer’s 401(k). The money will also continue to grow tax-deferred
in the new account.
6) Why can’t I simply rollover from my old
employer to my new employer’s 401(k) plan?
You can definitely do this, but note that you
will not have as many investment choices as an IRA can offer. In
the example above, Fidelity offers over 4600 4 and 5 star mutual
funds (rated by Morningstar) that you will not have available through
your new employer’s 401k plan. In fact, you might only be
limited to your employer’s stock. Also, at an IRA brokerage
such as Fidelity, you will get your own investment advisor that
knows finance and investments and can help you manage your money,
while your employer’s 401(k) plan might not offer such services
as the administrative costs can be very high.