There are many reasons why you might want to move your retirement savings to another account.
Maybe you want to invest with a company with better performance. Maybe you changed jobs and want to bring past accumulations with you to a new plan. If you’re among the millions who lost a job as the economy contracted, you may need to find a new home for your savings. Or maybe you just want to tidy up and consolidate investments that have landed in many employer-sponsored plans over the years.
In any case, it’s important to do this properly, so you avoid any mistakes that will incur taxes and early withdrawal penalties.
Tax-deferred savings can be moved to the same kind of tax-advantaged account—from an Individual Retirement Account to another IRA, or from a 401(k) to another 401(k), for example—in a transfer with no taxes or early withdrawal penalties.
When moving funds across different types of accounts, it’s called a rollover, and there are two kinds: direct and indirect rollovers.
A direct rollover is straightforward. Your financial institution or plan administrator simply transfers the funds straight into another retirement account that you designate, and you never touch the money. The full account balance is paid out and no taxes are owed.
Sometimes the plan administrator will cut you a check, but it’s made out to the new retirement plan, with the added qualifier of “for the benefit of [your name.]” It’s your responsibility to deposit that check promptly. Since you can’t cash an FBO check, it doesn’t count as income you received and is not taxable.
With an indirect, or 60-day rollover, you basically cash out the fund and make sure you deposit the full amount in a tax-deferred fund within 60 days. If you don’t deposit in time, you will owe income tax, plus an early withdrawal penalty if you take the distribution before age 59 ½.
There is another catch. If you take the rollover distribution payout as a personal check, the plan administrator is required to withhold 10% to cover taxes if you fail to deposit it in a fund in time. From 401(k)s and other employer retirement plans, 20% is withheld.
Despite this withholding, the Internal Revenue Service requires you to deposit the full balance of the old account in the new one. You must come up with cash to make up for the amount withheld within 60 days to deposit the full balance. The funds withheld from the old plan will be returned in the form of a tax credit.
Why bother with an indirect rollover? It does offer an opportunity to profit. You’re free to use the disbursed money within that 60 days. Potentially, you could invest it in a short-term, high-yield vehicle and make a quick, taxable return. This is obviously risky; if your investment loses money, you’ll have to come up with cash to cover the loss. If you can’t reinvest the full amount in a qualified fund, you will owe income tax plus a 10% early withdrawal penalty.
You may not need to move the money at all. The terms of an employer plan may allow you to just let the funds sit and continue to grow without additional contributions. This lets you take advantage of large company plans with the scale to negotiate for a wide range of attractive investment options and rates. However, some 401(k) plans automatically close out accounts with balances of less than $5,000. If that’s the case, you’ll need to find a tax-deferred home for those funds quickly.
One other reason to hang on to an old 401(k) is that if you are age 55 or older and lose your job, you can draw money from the fund without early withdrawal penalties that usually apply before age 59 ½. This is not allowed with IRAs.
Almost every investment company will tell you that rollovers are easy and pain-free, but there are requirements that can cost you if you don’t know the rules and don’t hit the 60-day window. We can help clarify the requirements and take the guesswork out of rollovers.
We are Arbor Wealth Management, a Phoenix-based firm that offers comprehensive financial planning services. We’re partners in your financial future. Like a conductor coordinating a beautiful symphony, we’re intimately involved in your financial future. We take the time to know how each instrument in your personal orchestra is performing, keeping all aspects of your plan in tune. We accomplish this by making sure your finances remain pliable, whether you are in an accumulation or distribution stage in life.
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