Rollover IRA: How to Roll Over Your 401 (k) and Save on Taxes

Rollover IRA – If you have a 401 (k) or another employer-sponsored retirement plan, you may be wondering what to do with it when you leave your job. One option is to roll over your 401 (k) to an IRA, which can offer you more control, flexibility, and investment choices for your retirement savings.

In this article, we will explain what a rollover IRA is, how it works, what the benefits and drawbacks are, and how to do a rollover IRA step by step.

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What Is a Rollover IRA?

A rollover IRA is an individual retirement account that accepts funds from your former employer-sponsored retirement plan, such as a 401 (k), 403 (b), or profit-sharing plan. The purpose of a rollover IRA is to maintain the tax-deferred status of your retirement assets without paying current taxes or early withdrawal penalties at the time of transfer.

A rollover IRA can be either a traditional IRA or a Roth IRA, depending on the type of your original plan and your preference. A traditional IRA allows you to make pre-tax contributions and pay taxes when you withdraw money in retirement. A Roth IRA allows you to make after-tax contributions and enjoy tax-free withdrawals in retirement.

How Does a Rollover IRA Work?

There are two ways to move your money from your old 401 (k) to a rollover IRA: a direct rollover or an indirect rollover.

Direct Rollover

A direct rollover is the easiest and most recommended way to do a rollover IRA. In this method, you ask your former employer’s plan administrator to transfer your 401 (k) balance directly to your rollover IRA provider. You don’t have to touch the money or deal with any paperwork. The direct rollover is also tax-free and penalty-free, as long as you follow the rules.

Indirect Rollover

An indirect rollover is a more complicated and risky way to do a rollover IRA. In this method, you ask your former employer’s plan administrator to send you a check for your 401 (k) balance. You then have 60 days to deposit the money into your rollover IRA provider. If you miss the deadline, the money will be treated as a taxable distribution and subject to income tax and a 10% early withdrawal penalty.

Another drawback of the indirect rollover is that your former employer’s plan administrator may withhold 20% of your 401 (k) balance for federal income tax purposes. This means that you will have to come up with the missing 20% from your own pocket and deposit it into your rollover IRA within 60 days. You can get the withheld amount back when you file your tax return, but it may cause you cash flow problems in the meantime.

What Are the Benefits of a Rollover IRA?

A rollover IRA can offer you several advantages over leaving your money in your old 401 (k) or taking a cash distribution. Some of the benefits are:

More investment options: A rollover IRA can give you access to a wider range of investment choices, such as stocks, bonds, ETFs, mutual funds, CDs, and more. You can also diversify your portfolio across different asset classes and sectors.
Lower fees: A rollover IRA may have lower fees than your old 401 (k), depending on the provider and the investments you choose. Some providers charge no account opening or maintenance fees for IRAs, while others may charge commissions, fund expenses, or other fees. You should compare the fee structures of different providers and investments before making a decision.
Easier management: A rollover IRA can make it easier for you to manage your retirement savings in one place. You don’t have to keep track of multiple accounts with different providers, rules, and statements. You can also consolidate multiple old 401 (k)s into one rollover IRA if you have changed jobs several times.
Tax benefits: A rollover IRA can help you preserve the tax-deferred status of your retirement assets and avoid paying taxes and penalties at the time of transfer. You can also choose between a traditional IRA or a Roth IRA depending on your tax situation and preference.

What Are the Drawbacks of a Rollover IRA?

A rollover IRA is not without its drawbacks. Some of the disadvantages are:

Loss of creditor protection: A rollover IRA may not have the same level of protection from creditors as your old 401 (k). Depending on your state laws, some or all of your 401 (k) assets may be exempt from bankruptcy or lawsuits, while your IRA assets may not be. You should consult with a legal or financial advisor before doing a rollover IRA if you have any concerns about creditor protection.
Loss of plan features: A rollover IRA may not have some of the features that your old 401 (k) had, such as employer matching contributions, loan options, or hardship withdrawals. You should weigh the pros and cons of these features before doing a rollover IRA.
Potential tax consequences: A rollover IRA may have different tax implications than your old 401 (k), depending on the type of your original plan and the type of your rollover IRA. For example, if you roll over a pre-tax 401 (k) to a Roth IRA, you will have to pay income tax on the amount you convert. If you roll over a Roth 401 (k) to a traditional IRA, you will lose the tax-free benefit of your Roth 401 (k). You should consult with a tax advisor before doing a rollover IRA if you have any questions about the tax consequences.

How to Do a Rollover IRA Step-by-Step

If you decide to do a rollover IRA, here are the steps you need to follow:

Choose a rollover IRA provider

You can choose any financial institution that offers IRAs, such as a bank, brokerage firm, mutual fund company, or online platform. You should compare the fees, services, investment options, and customer reviews of different providers before making a choice.

Open a rollover IRA account

You can open a rollover IRA account online or by phone with your chosen provider. You will need to provide some personal and financial information, such as your name, address, Social Security number, and bank account details. You will also need to choose between a traditional IRA or a Roth IRA, depending on your preference and eligibility.

Request a direct rollover from your old 401 (k)

You can contact your former employer’s plan administrator and ask them to do a direct rollover of your 401 (k) balance to your rollover IRA account. You will need to provide them with your rollover IRA account number and routing number. They will then transfer the money electronically or by check to your rollover IRA provider.

Invest your rollover IRA funds

Once the money is in your rollover IRA account, you can start investing it according to your retirement goals and risk tolerance. You can choose from various investment options offered by your rollover IRA provider or seek professional advice if you need help.

In conclusion, A rollover IRA is an option for transferring your retirement savings from your old 401 (k) or other employer-sponsored plan to an IRA when you leave your job. A rollover IRA can offer you more control, flexibility, and investment choices for your retirement savings, as well as tax benefits and lower fees. However, a rollover IRA also has some drawbacks, such as loss of creditor protection, loss of plan features, and potential tax consequences.

Rollover IRA: Frequently Asked Questions (F&Qs)

Can I rollover an IRA into a brokerage account?

Yes, you can rollover an IRA into a brokerage account. Here are some steps you can follow:

Distribute shares of investments from your IRA to satisfy the RMD requirements. These shares can then stay invested in a non-retirement brokerage account.
Open a rollover IRA with a brokerage firm and have the funds from your old 401(k) moved into the account.
Transfer the assets from your 401(k) to a Roth or Traditional IRA.
Roll over a 401(k) to an online broker or a robo-advisor.

Please keep in mind that there are contribution and income limits to rollover IRAs. Also, remember that amounts that must be distributed during a particular year under the required minimum distribution rules are not eligible for IRA rollover treatment. If you receive the proceeds of your 401(k) to invest in a rollover IRA, it is very important that you complete the process within 60 days. If you miss this deadline, you will be subject to taxes.

Can I withdraw from a rollover IRA brokerage account?

Yes, you can withdraw money from your rollover IRA, but there are a few things to keep in mind:

Taxes and Penalties: You may end up paying income taxes or an early withdrawal penalty if you’re not careful. The U.S. Internal Revenue Service (IRS) has created a 10% penalty tax to discourage people from taking out their retirement money too soon. Once you reach age 59½, you avoid this penalty.
Exceptions to Early Withdrawal Penalty: The IRS has provided exceptions to the 10% penalty before age 59½ for IRAs and other retirement plans. These include situations such as death, disability, unreimbursed medical expenses above 10% of adjusted gross income, and a series of substantially equal payments.
Roth IRA Withdrawals: For Roth IRAs—which are funded with after-tax money—there’s an additional rule you must meet to avoid the 10% penalty tax on account earnings, called the five-year rule.
60-Day Rule: If you receive the proceeds of your 401(k) to invest in a rollover IRA, it is very important that you complete the process within 60 days. If you miss this deadline, you will be subject to taxes.

Remember, withdrawing from a Rollover IRA requires careful consideration, given the intricate tax implications, potential penalties, and overarching strategies involved