9 Important Details about Early Retirement Plan Rollovers
by Ray Sagner on Jul 2, 2020
You’re probably aware that there are many options for retirement planning including 401(k)s, IRAs, Roth IRAs, and more. Some of the more common plans are employer-sponsored ones like 401(k)s, 403(b)s, and 457(b)s. These arrangements have higher contribution limits and let employees save for retirement on a post-tax or a tax-deferred basis, which is more typical.
However, as individuals move from job to job or employer to employer, they are faced with decisions about what to do with their retirement accounts. Early retirement plan rollovers are a smart option for some individuals. But, like ay major money move, you should understand the pros and cons first to evaluate if this strategy supports your overall financial plan.
Won’t have to pay taxes or penalties
You won’t have to pay taxes or penalties with an early retirement plan rollover to an IRA. Most employer-sponsored plans and IRAs are tax-deferred accounts. This means that you’ll only be taxed at ordinary rates once you take distributions, not upon rollover.
So, rolling your 401(k) over into an IRA won’t subject you to a 10% penalty. However, you will be subject to these penalties and taxes if you cash out your 401(k) or roll it over to a Roth IRA since Roth accounts collect taxes upon contribution.
Lower fees and wider investment options
Many IRAs have more variety in investment choices than 401(k) plans. You can invest in single stocks, bonds, ETFs, options, and other products that aren’t available via most employer-sponsored plans. Also, most IRA investments have lower fees than some employer-sponsored plans.
For instance, some 401(k)s have mutual funds with expense ratios greater than 1%. This might not seem like much, but the difference between a 0.1% and 1% expense ratio can cost you hundreds of thousands of dollars long-term.
Easier to manage
It’s becoming rare to find employees that stay at a company for decades as the average job tenure is approximately 4 years. Rolling over past 401(k)s into a single IRA will let you or your advisor manage the money easier. Early retirement plan rollover funds will be consolidated and it will be easier to track gains, expenses, and other important details.
Flexible withdrawal exceptions
Besides the new CARES act penalty-free withdrawal rules, IRAs and Roth IRAs have special exceptions for penalty-free withdrawals. Currently, you can withdraw up to $10,000 from either of these accounts for higher education costs or a down payment for a first time home purchase. You can apply this rule to each special case just once over your lifetime.
Some other special circumstances that qualify for this rule include unreimbursed medical expenses, health insurance premiums when unemployed, and permanent disability.
Being able to access robo advisors
Robo advisors have changed investing as they can automate some aspects of portfolio management like asset allocation, tax-loss harvesting, and rebalancing.
This technology can perform these functions for a fraction of the cost compared to a portfolio manager’s fees. Usually, a Robo advisor charges 0.10% - 0.40% of assets under management (AUM), and the typical portfolio manager’s AUM fee is approximately 1%. Many IRA custodians like Charles Schwab and Fidelity have Robo advisors.
Can make it harder to retire early or later
Age 59.5 is the cutoff for taking penalty-free withdrawals from 401(k)s. Yet, most people don’t know about the Rule of 55. This little known rule will let you take penalty-free withdrawals from your current employer’s retirement plan once you turn 55. If you do an early retirement plan rollover, then you’d have to wait until you turn 59.5 to take penalty-free withdrawals.
Another important factor to consider is the required minimum distributions or RMDs. This rule requires you to take a distribution from your IRAs and 401(k)s once you turn 72. If you plan on working into your 70s, consider keeping money in your employer’s 401(k). Funds in your current employer’s 401(k) will not be subject to RMDs, unlike those in IRAs.
Less protection from lawsuits and creditors
401(k)s offer more protection from lawsuits and creditors under the Employee Retirement Income Security Act of 1974 or ERISA act. If you someone wins a judgment against you in a lawsuit, then your 401(k) funds are protected. IRA funds don’t offer the same legal protection and IRA protections can vary per state.
Employer-sponsored retirement accounts are also protected from bankruptcy. IRAs balances are protected up to roughly $1,200,000 which is adjusted for inflation annually.
Can’t borrow from IRAs
While it’s not advised, you can borrow up to the lesser of 50% of your vested account balance or $50,000 from your 401(k) or 403(b). Loans might be useful during times of hardship and as a last resort. However, you must pay these funds back with interest or you’d face penalties and ordinary income taxes. Also, you’d also miss out on potential market gains by taking a loan from your retirement plan.
IRAs have some flexibility with penalty-free distributions, but you can’t borrow against them as you could with employer-sponsored plans.
Higher taxes on company stock and NUA
If you have a substantial company stock position in a 401(k), think twice before doing an early retirement plan rollover to an IRA. Rolling over company stock could lead to higher income taxes on the NUA. The NUA is simply the difference between the original price (i.e. cost basis) of the company stock when you received it and its current value when rolled over.
You won’t pay taxes on company stock that’s moved to an IRA. But, you’ll have to pay higher ordinary rates when you sell it. If you move the stock to a brokerage account, you’d pay higher ordinary rates on your cost basis. Luckily, you’d only pay lower capital gains rates when you sell the stock.
There are many tools that you can use to save for retirement, but employer-sponsored plans like 401(k)s and 403(b)s are some of the more standard options. It’s important to understand how they will fit into your long-term plan before deciding to perform a rollover.
Unsure of your options with early retirement plan rollovers? Schedule a free consultation with one of our financial professionals today!
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2023 Advisor Websites.