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3 Questions You Have To Answer Before doing a 401k Rollover

401k Rollover

You might have heard a lot about the 401k rollover and how it is a great benefit for retirement planning. A rollover allows you to take money out of your 401k and use it to fund your retirement, and it is a great benefit for saving money in your retirement, as well. But how do you know when to rollover a 401k?

When to rollover your 401k depends a lot on what you are looking to do with it. Some people rollover their 401ks when they are about to retire, while others rollover their 401k for other reasons such as a change of jobs.

Roth vs. Traditional

Before getting into details first we should clarify the type of 401k that you have. If you have Traditional 401k that means that your money and contributions grow pre-tax and the way it works is that you’re not going to be charged until you “retire” or withdraw your money. It would make a lot of sense if you are planning to retire in a lower tax bracket. On the other side, the Roth 401k works the same as the Traditional with the only exception that the profits and contributions grow tax-free.

401k Rollover

After reviewing this you might say that the Roth 401k is the best idea, but don’t go to fast! Remember that the money that you contribute to your Roth 401k is already taxed, and if you are in a high tax bracket right now it might not be the best path to go. Plus you can’t deduct your after-taxed money, which in the Traditional 401k you can, and this can be very tax-efficient sometimes. However, it is always better to get the numbers right and hire a Certified Financial Planner that can help you get the right numbers.

There are some things you have to take in consideration before making the decision to rollover your 401k plan. But first you have to ask yourself three questions, and after you know the answers you can make an educated decision whether to rollover 401k or not, and before you choose to rollover it, it’s important that you know your options.

The Traditional 401k works the best if your employer matches it, and if you’re a high income earner and want to deduct a part of your money so you can benfit from it in your retirement.

For this particular example I’m going to take for granted that you have a Traditional 401k.

First Question: What to do if you change jobs?

  • If you have more than 5k you can leave the money in the account even if you change jobs, however, you wouldn’t be able to contribute to it.
  • If you are changing jobs, one option could be to rollover your 401k plan to your new employer’s plan.
  • Cash the money out (worst options due to taxation)
  • 401k Rollover to Traditional IRA

Second Question: Why should I Not Rollover My 401k into an IRA?

  • The age 55 withdrawal rule: this states that there is not a 10% withdrawal penalty after 55, but profits are still taxable.
  • If you are planning to work until 70
  • Net Unrealized Depreciation (explained below)
  • Contribution limitations: If you rollover your 401k into a Traditional IRA you’ll have a Contribution Limit of $6,000 per year or $7,000 if you are above 50 years old
  • No more employee match, consequently less money to deduct

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Third Question: Why should I Rollover My 401k into an IRA?

  • If you have more than 5k you can leave the money in that account even if you change jobs, but you wouldn’t be able to contribute to it anymore
  • Access to better investment options
  • Possibility to lower your Fees
  • With a 401k is difficult to track investments, IRA investments are easy to track
  • Estate Planning. With an IRA is easier to choose beneficiaries than with a 401k
  • RMD’s Flexibility

What is Net Unrealized Appreciation?

What this basically means is that if you have any highly appreciated company stock in your 401k, you can pull your money out of that stock and you’ll only going to pay ordinary income taxes on the price basis of your stock. For example, if you have stock that is worth $50,000 dollars and the cost basis was $10,000 then you will have to pay only taxes on the $10,000 and the gain ($40,000) will be classified as Net Unrealized Depreciation and can qualify as long-term capital gain tax, which is much lower than paying ordinary income tax.

Annuity Lessons

What If You Decide to Rollover your 401k?

It is important that if you rollover your 401k you ask for a “Direct” rollover to your IRA account. Do not ask them to write a check to you directly, because the IRS is going to tax you. In case you decide to rollover your 401k, the smart move would be to rollover your 401k to a Traditional IRA or to your other employer 401k plan because that’d not have any tax implications for you at all. Always remember that It’s not recommended to withdraw cash from your 401k due to taxation.

If you decide to rollover your 401k into a Traditional IRA then the next step would be to pick your investments. For this we recommend you schedule a meeting with a Certified Financial Planner™ Professional to run the numbers and create the best scenario for your specific situation.

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AnnuityEdu’s Take

401k Rollover

After reviewing the benefits of each option we can conclude that whether you rollover your 401k or not t will depend on your expectations and your current financial situation. Not every option is perfect but with a little research and after getting all the numbers right, you can make the best decision for your retirement.

If you rollover your 401k to your new employer’s retirement plan you’d be limited to your new employer’s investment options with potentially high fees, but if you are a high-income individual and your employer offers you a 401k match, you might benefit from this option. If you rollover your 401k to a Traditional IRA you will limit your contributions, however, you will also be able to pick better investments and have possibly lower fees. After reviewing all this, we can say that leaving your 401k money with your last employer or cashing your money out are the worst options in any situation. So Make sure you do your research and ask for help before making any rash decision.

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