Did you recently start a new job and had a 401(k) plan at your prior employer? If so, you may need to decide on the next course of action for your existing 401(k) funds. Many individuals neglect to properly handle their 401(k)s when a new job is started or a new plan administrator is in place, calling on the need to understand the basics of a rollover, alternative options, and how to decide on the right option for you.
What is a 401(k) Rollover?
A 401(k) rollover occurs when eligible retirement funds are moved from one plan to another. The most common situation that gives way to the need for a rollover is switching jobs. The existing funds in your retirement account need to be properly transferred over to the new plan administrator. Neglecting to roll the funds in the specified time frame results in the funds being taxed by federal and state agencies.
The first tax that will be assessed is a 10% early withdrawal penalty, if you are withdrawing the funds prior to 59 ½ years of age. In addition, the funds you receive will then be taxed at ordinary income rates at both the federal and state level when you file your individual tax return. Paying taxes on the funds prematurely can lead to less income when you retire since compound interest will be assessed on a lower amount.
What are the Different Ways to Complete a Rollover?
There are three main types of 401(k) rollovers: a direct rollover, trustee-to-trustee transfer, and 60-day rollover. Each of these three methods requires a different set of policies and procedures to be employed. The first way, a direct rollover, can be done by asking your previous plan administrator to pay the funds directly to the next plan, bypassing any distribution to you. There will be no early withdrawal penalty or taxes withheld in a direct rollover.
The next 401(k) rollover option, a trustee-to-trustee transfer, occurs when the financial institution holding your funds remits the amount directly to the new retirement plan. Similar to a direct rollover, there will be no adverse tax effects with this option. In a trustee-to-trustee transfer, the funds will bypass you and go directly to the new plan, cutting out any middleman.
The final rollover option, a 60-day rollover, makes you the middleman in the rollover process. Unlike the first two 401(k) rollover options, the funds will be disbursed to you, leaving you with the responsibility to remit the funds to the new plan administrator. You will have 60 days from the disbursement date to send the funds to the new account or you will be assessed penalties and be required to pay taxes.
Other Options for Your 401(k) Funds
Although a 401(k) rollover is a popular option for many individuals when they switch jobs, there are alternative options available. One option is to leave the funds with the old plan administrator. There will be no additional contributions by you or the employer to the account, leaving the existing funds in the account to grow. Your old employer may have regulations around leaving funds, so be sure to double check. Another option is to take a total distribution from the old account, subjecting you to income taxes and an early withdrawal penalty if you are under 59 ½. Depending on the amount of funds in the account and related tax implications, a total distribution might be a viable option for your financial situation.
Deciding Between Different Options
When it comes time to decide on the right strategy for you, there are a few different factors to consider. The first factor to analyze is the features of each plan option. Each 401(k) plan provides a pre-determined set of investment options, some of which can be more beneficial to your individual situation. Take a look at the investment options in each plan before making the decision to rollover or leave the funds. Moreover, each retirement plan comes with costs that are pulled from your account. Like the investment options, you will need to understand when costs are assessed and the amounts before making a decision on your old 401(k). Other factors to consider include the option to take penalty-free withdrawals, creditor protection, service options available and the process of required minimum distribution applications.
How Do I Know Which Option is Best?
Deciding on the right move for your old 401(k) can be tricky, which is why consulting with an expert is always advised. BLU Financial Planning has helped various individuals work through tough financial situations through careful planning and accurate advising. Choosing the wrong option cannot only impact your current tax burden, but it can also hinder your funds at retirement. Instead, of guessing on which option is best for your individual financial situation, contact the team at BLU Financial Planning to set up a consultation today.
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